Johannes Wohlfart, University of Copenhagen: Mental models of the stock market
Co-authors: Peter Andre (briq) and Philipp Schirmer (Bonn Graduate School of Economics)
Abstract: We study the mental models of the stock market held by different types of economic agents. In large-scale surveys with the general population, financial professionals, and academic experts, we present participants with hypothetical scenarios featuring stale news with implications for the future earnings streams of companies. We distinguish between different mental models based on respondents' forecasts regarding returns, earnings and risk factor exposure over varying horizons, supplemented with rich data on reasoning. Academic experts predominantly adhere to beliefs in efficient markets. Financial professionals and households tend to naively equate higher future earnings with higher future returns, neglecting the offsetting effect of endogenous price adjustments. Using a series of experimental interventions, we demonstrate that naive forecasts reflect unfamiliarity with the concept of equilibrium rather than inattention to trading or price responses. Our results provide a new perspective on previously documented anomalies in return expectations and trading decisions.