Abstract
We hypothesize that the well-documented negativity bias, the psychological tendency to asymmetrically emphasize negative over positive aspects, can help explain several financial market phenomena: why most individuals hold strongly bearish views of both short- and long-term equity return distributions, why individuals exhibit heterogeneous beliefs, and the stock market participation puzzle. Using variation in the perceived risk of mortality from the swine flu pandemic as our primary proxy for an individual's negativity bias, we find strong support for our hypothesis even when controlling for alternative mechanisms including optimism, risk aversion, ambiguity aversion, and anxiety.
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