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Expectations of risk and return among household investors: Are their Sharpe ratios countercyclical?

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Author Info

  • Gene Amromin
  • Steven A. Sharpe

Abstract

Data obtained from special questions on the Michigan Survey of Consumer Attitudes are used to analyze stock market beliefs and portfolio choices of household investors. We find that expected risk and return are strongly influenced by economic prospects. When investors believe macroeconomic conditions are more expansionary, they tend to expect both higher returns and lower volatility. This implies that household Sharpe ratios are procyclical, which is inconsistent with the view that stock market returns should compensate investors for exposure to macroeconomic risks. The finding of procyclical expected returns holds up when we instead condition on conventional business cycle proxies such as the dividend yield and the consumption-wealth ratio. We further find that perceived risk in equity returns (though not the expected returns themselves) is strongly influenced by household investor characteristics, consistent with documented behavioral biases. The relevance of investor expectations is supported by the finding that the proportion of equity holdings in respondent portfolios tends to be higher for those who report higher expected returns and lower uncertainty.

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Bibliographic Info

Article provided by Federal Reserve Bank of San Francisco in its journal Proceedings.

Volume (Year): (2009)
Issue (Month): Jan ()
Pages:

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Handle: RePEc:fip:fedfpr:y:2009:i:jan:x:1

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Keywords: Financial markets;

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References

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Cited by:
  1. James Crotty, 2009. "Structural causes of the global financial crisis: a critical assessment of the 'new financial architecture'," Cambridge Journal of Economics, Oxford University Press, vol. 33(4), pages 563-580, July.
  2. Tobias Adrian & Daniel Covitz & Nellie J. Liang, 2013. "Financial stability monitoring," Staff Reports 601, Federal Reserve Bank of New York.

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