Which Subjective Expectations Explain Asset Prices?

Ricardo De la O · Sean Myers

33 citations0/0 files storedReview of Financial Studies

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Financial Markets and Investment Strategies Monetary Policy and Economic Impact Economic theories and models

Abstract

Abstract We present a method for determining whether errors in expectations explain asset pricing puzzles without imposing assumptions about the error mechanism. Using accounting identities and survey forecasts, we find that errors in expected long-term inflation explain price variation, return predictability, and the rejection of the expectations hypothesis for aggregate stock and bond markets. Errors in short-term (long-term) nominal earnings growth expectations explain (do not explain) stock price variation and return predictability. The relevant errors are consistent with mistakes about the persistence of forecasted variables and the response to surprises. A simple framework based on fundamental extrapolation successfully replicates these findings. (JEL G40, G12, G14, E71)

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References

1988The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors 1998A model of investor sentiment1We are grateful to the NSF for financial support, and to Oliver Blanchard, Alon Brav, John Campbell (a referee), John Cochrane, Edward Glaeser, J.B. Heaton, Danny Kahneman, David Laibson, Owen Lamont, Drazen Prelec, Jay Ritter (a referee), Ken Singleton, Dick Thaler, an anonymous referee, and the editor, Bill Schwert, for comments.1 1988Stock Prices, Earnings, and Expected Dividends 2002Sticky Information versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve 2011Presidential Address: Discount Rates 2013Handbook of the Economics of Finance 2003A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables 2014Expectations of Returns and Expected Returns

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