Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/267300 
Year of Publication: 
2022
Series/Report no.: 
CESifo Working Paper No. 10067
Publisher: 
Center for Economic Studies and ifo Institute (CESifo), Munich
Abstract: 
We show theoretically that the weak transmission of beliefs to actions induces a strong bias in basic asset pricing tests. In particular, expected returns can appear to decline in risk when investors weakly transmit their payoff expectations into willingness to pay. We experimentally test this prediction and find that subjects exhibit an extremely weak transmission of beliefs to actions, which generates a negative risk-return relation. We argue that the weak transmission is due to cognitive noise and demonstrate that cognitive noise causally affects the risk-return relation. Our results highlight the importance of incorporating weak transmission into belief-based asset pricing models.
Subjects: 
investor behavior
cognitive noise
portfolio choice
Document Type: 
Working Paper
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