Recovering Investor Expectations from Demand for Index Funds. (7th December 2021)

• Record Type: Journal Article
• Authors: Egan, Mark; MacKay, Alexander; Yang, Hanbin
• Is Part Of: Review of economic studies. Volume 89:Number 5(2022)
• Page Start: 2559
• Page End: 2599
• Publication Date: 2021-12-07
• Subjects: Stock market expectations -- Demand estimation -- Exchange-traded funds (ETFs); D12 -- D81 -- D84 -- G11 -- G50 -- L0; Economics -- Periodicals; 330
• DOI: 10.1093/restud/rdab086
• Languages: English
• ISSNs: 0034-6527

Abstract

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 future returns across investors. 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. Our estimates indicate 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 due to the presence of contrarian investors.