Mental Models of the Stock Market

Arbeitspapier

Investors' return expectations are pivotal in stock markets, but the reasoning behind these expectations remains a black box for economists. This paper sheds light on economic agents' mental models – their subjective understanding – of the stock market, drawing on surveys with the US general population, US retail investors, US financial professionals, and academic experts. Respondents make return forecasts in scenarios describing stale news about the future earnings streams of companies, and we collect rich data on respondents' reasoning. We document three main results. First, inference from stale news is rare among academic experts but common among households and financial professionals, who believe that stale good news lead to persistently higher expected returns in the future. Second, while experts refer to the notion of market efficiency to explain their forecasts, households and financial professionals reveal a neglect of equilibrium forces. They naively equate higher future earnings with higher future returns, neglecting the offsetting effect of endogenous price adjustments. Third, a series of experimental interventions demonstrate that these naive forecasts do not result from inattention to trading or price responses but reflect a gap in respondents' mental models – a fundamental unfamiliarity with the concept of equilibrium.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: CESifo Working Paper ; No. 10691

Classification and Topics

• Classification: Wirtschaft ; Search; Learning; Information and Knowledge; Communication; Belief; Unawareness ; Expectations; Speculations ; Portfolio Choice; Investment Decisions ; Asset Pricing; Trading Volume; Bond Interest Rates ; Behavioral Finance: Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets‡
• Subject: mental models ; return expectations

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Andre, Peter ; Schirmer, Philipp ; Wohlfart, Johannes
• Event: Veröffentlichung
• (who): Center for Economic Studies and ifo Institute (CESifo)
• (where): Munich
• (when): 2023

Further information

• Handle: http://hdl.handle.net/10419/282379
• Last update: 10.03.2025, 11:44 AM CET