NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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Recovering Investor Expectations from Demand for Index Funds

Mark L. Egan, Alexander MacKay, Hanbin Yang

NBER Working Paper No. 26608
Issued in January 2020, Revised in May 2020
NBER Program(s):Asset Pricing, Corporate Finance, Industrial Organization

We use a revealed-preference approach to estimate investor expectations of stock market returns. Using data on demand for index funds that follow the S&P 500, we develop and estimate a model of investor choice to flexibly recover the time-varying distribution of expected returns. Our analysis is facilitated by the prevalence of “leveraged” funds that track the same underlying asset: by choosing between higher and lower leverage, investors trade off higher return against less risk. Although generated from a different method (realized choices) and a different population, our quarterly estimates of investor expectations are positively and significantly correlated with the leading surveys used to measure stock market expectations. Our estimates suggest that investor expectations are heterogeneous, extrapolative, and persistent. Following a downturn, investors become more pessimistic on average, but there is also an increase in disagreement among participating investors.

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Document Object Identifier (DOI): 10.3386/w26608

 
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