Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/298541 
Year of Publication: 
2024
Series/Report no.: 
CEBI Working Paper Series No. 07/23
Version Description: 
Revised: March 28, 2024
Publisher: 
University of Copenhagen, Department of Economics, Center for Economic Behavior and Inequality (CEBI), Copenhagen
Abstract: 
Investors' return expectations are pivotal in stock markets, but the reasoning behind these expectations remains a black box for economists. This paper sheds light on economic agents' mental models - their subjective understanding - of the stock market, drawing on surveys with the US general population, US retail investors, US financial professionals, and academic experts. Respondents make return forecasts in scenarios describing stale news about the future earnings streams of companies, and we collect rich data on respondents' reasoning. We document three main results. First, inference from stale news is rare among academic experts but common among households and financial professionals, who believe that stale good news lead to persistently higher expected returns in the future. Second, while experts refer to the notion of market efficiency to explain their forecasts, households and financial professionals reveal a neglect of equilibrium forces. They naively equate higher future earnings with higher future returns, neglecting the offsetting effect of endogenous price adjustments. Third, a series of experimental interventions demonstrate that these naive forecasts do not result from inattention to trading or price responses but reflect a gap in respondents' mental models - a fundamental unfamiliarity with the concept of equilibrium.
JEL: 
D83
D84
G11
G12
G41
G51
G53
Document Type: 
Working Paper

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