Stock Market Expectations and Risk Perception of Professionals: Difference between Asking for Price Levels and Asking for Returns

• Applicants: Professor Dr. Markus Glaser; Privatdozent Dr. Michael Schröder
• Subject Area: Accounting and Finance ; General, Cognitive and Mathematical Psychology
• Term: from 2013 to 2016
• Project identifier: Deutsche Forschungsgemeinschaft (DFG) - Project number 240375697

In the recent decades, economic research has begun to intensively analyze the role of agents' expectations for economic outcomes. Academic studies acknowledge that the link between a piece of information and subsequent market development is inevitably the perception of information by economic actors and their decision making. Normative theories on rational expectation formation and decision making assume that people have clear subjective beliefs, which are invariant with respect to the manner in which information is represented and the manner in which they are elicited. However, violations of the two assumptions of invariance, denoted as framing effect, are documented in an extensive body of literature. Within the scope of this project we will focus on the difference in stock market expectations arising when individuals are asked to forecast the stock price level or the stock return. Questions on returns and price levels are of high ecological validity as they are both used in regular real-world surveys and are typically regarded as interchangeable in practice as well as in research. Recent experimental evidence, however, suggests that these two questions result in significantly different forecasts and, furthermore, have an impact on subjective risk perception. An initial validation based on the ZEW Financial Market Survey suggests that the effect is more than an artifact of experimental studies with students and is a relevant issue when considering expectations of stock market professionals. The results thus motivate further research on the effect as suggested in this proposal. The real-world implications of the effect may span from the validity and reliability of survey-based sentiment indicators to biases in investment decisions and hence financial market variables. This project will examine the difference between asking for stock price levels and asking for returns in a real-world setting and will analyze the determinants of the effect in order to draw conclusions on the scope of its impact. Furthermore, the project will evaluate both forecasts modes in terms of forecast quality over time and in a cross-section. Last but not least, we will analyze which representation form - levels vs. returns - would individuals choose endogenously for different tasks (forecasting and investment decisions). We will address these research questions firstly within the scope of a quarterly repeated field experiment conducted with the participants in the panel of ZEW Financial Market Survey and secondly, by means of experimental data which will be collected within the scope of a lab experiment and two internet experiments with both business students and practitioners.

• DFG Programme: Research Grants