Stock Market Optimism and Portfolio Allocation of American Households

Abstract

This paper employs subjective stock market expectation responses from Health and Retirement Survey as a proxy for stock market optimism of American households. I first ask if individuals are inert in terms of forming their optimistic stock market views. Second I analyze the impact of optimism on portfolio allocation of individuals by disentangling between time-varying and time constant individual traits. To do the two stage estimation, I use the latterly enhanced bias correction method from Fernandez-Val and Vella (2011) which allows the estimation of a dynamic probit model with fixed effects and bias corrected mills ratio. My results reveal that stock market optimism is a persistent subjective perception where individuals are inert in their way off processing information and updating their beliefs. Additionally, optimistic individuals tend to invest more in risky assets in their financial portfolios where time-varying individual specific factors have adverse effects.