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    Recovering Investor Expectations from Demand for Index Funds
    24 Feb 2020Working Paper Summaries

    Recovering Investor Expectations from Demand for Index Funds

    by Mark Egan, Alexander J. MacKay, and Hanbin Yang
    Understanding investor beliefs, how beliefs are formed, and the dynamics of these beliefs is critical for explaining investment and saving behavior. This paper’s framework uses observed ETF trades to recover the distribution of investor expectations over the period 2008-2018 and provides new insights about the dynamics of these beliefs.
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    Author Abstract

    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.

    Paper Information

    • Full Working Paper Text
    • Working Paper Publication Date: January 2020
    • HBS Working Paper Number: NBER Working Paper Series, No. 26608
    • Faculty Unit(s): Finance; Strategy
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    Mark L. Egan
    Mark L. Egan
    Mark E. Kingdon Associate Professor of Business Administration
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    Alexander J. MacKay
    Alexander J. MacKay
    Assistant Professor of Business Administration
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    Hanbin Yang
    Hanbin Yang
    Doctoral Student in Negotiation, Organizations and Markets
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