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Is there Evidence of Pessimism and Doubt in Subjective Distributions? A Comment on Abel

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  • Giordani, Paolo

    () (Dept. of Economics, Stockholm School of Economics)

  • Söderlind, Paul

    () (Dept. of Finance, Stockholm School of Economics)

Abstract

Abel (2002) shows that pessimism and doubt in the subjective distribution of the growth rate of consumption reduce the riskfree rate puzzle and the equity premium puzzle. We quantify the amount of pessimism and doubt in survey data on US consumption and income. Individual forecasters are in fact pessimistic, but show marked overconfidence rather than doubt. Whether this implies that overconfidence should be built into Abel's model depends on how the empirically heterogeneous subjective distributions are mapped into the distribution of a fictitious representative agent. We work out the form of this mapping in an Arrow-Debreu economy and show that the equity premium increases with the dispersion of beliefs. We then estimate this aggregate distribution and find little evidence of either overconfidence or doubt.

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Bibliographic Info

Paper provided by Stockholm School of Economics in its series Working Paper Series in Economics and Finance with number 519.

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Length: 14 pages
Date of creation: 14 Dec 2002
Date of revision: 15 Aug 2003
Handle: RePEc:hhs:hastef:0519

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Keywords: equity premium; riskfree rate; aggregation of beliefs; Survey of Professional Forecasters; Livingston Survey;

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  1. Söderlind, Paul, 2000. "Inflation Forecast Uncertainty," CEPR Discussion Papers 2499, C.E.P.R. Discussion Papers.
  2. Detemple Jerome & Murthy Shashidhar, 1994. "Intertemporal Asset Pricing with Heterogeneous Beliefs," Journal of Economic Theory, Elsevier, vol. 62(2), pages 294-320, April.
  3. David Hirshleifer, 2001. "Investor Psychology and Asset Pricing," Journal of Finance, American Finance Association, vol. 56(4), pages 1533-1597, 08.
  4. Andrew B. Abel, 2001. "An Exploration of the Effects of Pessimism and Doubt on Asset Returns," NBER Working Papers 8132, National Bureau of Economic Research, Inc.
  5. Benartzi, Shlomo & Thaler, Richard H, 1995. "Myopic Loss Aversion and the Equity Premium Puzzle," The Quarterly Journal of Economics, MIT Press, vol. 110(1), pages 73-92, February.
  6. Varian, Hal R, 1985. " Divergence of Opinion in Complete Markets: A Note," Journal of Finance, American Finance Association, vol. 40(1), pages 309-17, March.
  7. Christoffersen, Peter F, 1998. "Evaluating Interval Forecasts," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 841-62, November.
  8. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  9. Nicholas Barberis & Ming Huang & Tano Santos, 2001. "Prospect Theory And Asset Prices," The Quarterly Journal of Economics, MIT Press, vol. 116(1), pages 1-53, February.
  10. Richard H. Thaler, 2000. "From Homo Economicus to Homo Sapiens," Journal of Economic Perspectives, American Economic Association, vol. 14(1), pages 133-141, Winter.
  11. Matthew Rabin, 1998. "Psychology and Economics," Journal of Economic Literature, American Economic Association, vol. 36(1), pages 11-46, March.
  12. Louis K. C. Chan & Jason Karceski & Josef Lakonishok, 2003. "The Level and Persistence of Growth Rates," Journal of Finance, American Finance Association, vol. 58(2), pages 643-684, 04.
  13. Rubinstein, Mark, 1974. "An aggregation theorem for securities markets," Journal of Financial Economics, Elsevier, vol. 1(3), pages 225-244, September.
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Cited by:
  1. Benjamin E. Hermalin & Michael S. Weisbach, 2012. "Information Disclosure and Corporate Governance," Journal of Finance, American Finance Association, vol. 67(1), pages 195-234, 02.
  2. Jouini, Elyes & Napp, Clotilde, 2006. "Heterogeneous beliefs and asset pricing in discrete time: An analysis of pessimism and doubt," Journal of Economic Dynamics and Control, Elsevier, vol. 30(7), pages 1233-1260, July.
  3. Jouini, Elyès & Napp, Clotilde, 2008. "On Abel's Concepts of Doubt and Pessimism," Open Access publications from Université Paris-Dauphine urn:hdl:123456789/198, Université Paris-Dauphine.
  4. Verma, Rahul & Soydemir, Gökçe, 2009. "The impact of individual and institutional investor sentiment on the market price of risk," The Quarterly Review of Economics and Finance, Elsevier, vol. 49(3), pages 1129-1145, August.
  5. Joseph Engelberg & Charles F. Manski & Jared Williams, 2006. "Comparing the Point Predictions and Subjective Probability Distributions of Professional Forecasters," NBER Working Papers 11978, National Bureau of Economic Research, Inc.
  6. Dreber, Anna & Rand, David G. & Garcia, Justin R. & Wernerfelt, Nils & Lum, J. Koji & Zeckhauser, Richard, 2010. "Dopamine and Risk Preferences in Different Domains," SIFR Research Report Series 71, Institute for Financial Research.
  7. Olivier Armantier & Nicolas Treich, 2006. "Overbidding in Independant Private-Values Auctions and Misperception of Probabilities," CIRANO Working Papers 2006s-15, CIRANO.
  8. Rydqvist, Kristian, 2010. "Tax Arbitrage with Risk and Effort Aversion - Swedish Lottery Bonds 1970-1990," SIFR Research Report Series 70, Institute for Financial Research.

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