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Past returns and the perceived Sharpe ratio

Author

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  • Kaplanski, Guy
  • Levy, Haim
  • Veld, Chris
  • Veld-Merkoulova, Yulia

Abstract

We find that human perception contradicts the market efficiency assertions that high expected returns are accompanied by high risk and that past returns are not correlated with future returns. A survey of investors reveals that the last month realized returns are positively correlated with next month perceived returns and that they are negatively correlated with perceived risk. Neither expected return nor perceived risk captures the entire effect. Thus, in the human mind the “perceived Sharpe ratio” is positively correlated with short-term past returns. The effect does not depend on gender, education, income, and portfolio value, but it is more profound among older investors.

Suggested Citation

  • Kaplanski, Guy & Levy, Haim & Veld, Chris & Veld-Merkoulova, Yulia, 2016. "Past returns and the perceived Sharpe ratio," Journal of Economic Behavior & Organization, Elsevier, vol. 123(C), pages 149-167.
    • Handle: RePEc:eee:jeborg:v:123:y:2016:i:c:p:149-167
    DOI: 10.1016/j.jebo.2015.11.010
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    Cited by:

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    3. Khan, Mohammad Tariqul Islam & Tan, Siow-Hooi & Chong, Lee-Lee, 2017. "How past perceived portfolio returns affect financial behaviors—The underlying psychological mechanism," Research in International Business and Finance, Elsevier, vol. 42(C), pages 1478-1488.
    4. Merkoulova, Yulia & Veld, Chris, 2022. "Why do individuals not participate in the stock market?," International Review of Financial Analysis, Elsevier, vol. 83(C).
    5. Dorfleitner, Gregor & Fischer, Lukas & Lung, Carina & Willmertinger, Philipp & Stang, Nico & Dietrich, Natalie, 2018. "To follow or not to follow – An empirical analysis of the returns of actors on social trading platforms," The Quarterly Review of Economics and Finance, Elsevier, vol. 70(C), pages 160-171.
    6. Broberg, Thomas & Kažukauskas, Andrius, 2021. "Information policies and biased cost perceptions - The case of Swedish residential energy consumption," Energy Policy, Elsevier, vol. 149(C).
    7. Stephen Brown & Chris Veld & Yulia Veld‐Merkoulova, 2020. "Credit Cards: Transactional Convenience or Debt‐Trap?," International Review of Finance, International Review of Finance Ltd., vol. 20(2), pages 295-322, June.

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    More about this item

    Keywords

    Expected return; Perceived risk; Perceived Sharpe ratio; Market efficiency; Random walk;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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