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Survey Expectations and the Equilibrium Risk-Return Trade Off

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  • Roberto Marfè

Abstract

Intuition and leading equilibrium models are at odds with the empirical evidence that expected returns are weakly related to volatility at the market level. This paper proposes a closed-form general equilibrium model, which connects the investors’ expectations of fundamentals with those of market returns, as documented by survey data. Forecasts suggest that investors feature pro-cyclical optimism and, then, overestimate the persistence of aggregate risk. The forward-looking component of stock volatility offset the transient risk and leads to a weak risk-return relation, in line with survey data about market returns. The model mechanism is robust to many features of financial markets.

Suggested Citation

  • Roberto Marfè, 2015. "Survey Expectations and the Equilibrium Risk-Return Trade Off," Carlo Alberto Notebooks 408, Collegio Carlo Alberto.
    • Handle: RePEc:cca:wpaper:408
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    File URL: https://www.carloalberto.org/wp-content/uploads/2018/11/no.408.pdf
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    More about this item

    Keywords

    risk-return trade off; survey expectations; general equilibrium; optimism; asset pricing puzzles; heterogeneous preferences; closed-form expression;
    All these keywords.

    JEL classification:

    • D51 - Microeconomics - - General Equilibrium and Disequilibrium - - - Exchange and Production Economies
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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