Lawrence J. Jin

Realization Utility with Reference-Dependent Preferences

We develop a tractable model of realization utility that studies the role of reference-dependent S-shaped preferences in a dynamic investment setting with reinvestment. Our model generates both voluntarily realized gains and losses. It makes specific predictions about the volume of gains and losses, the holding periods, and the sizes of both realized and paper gains and losses that can be calibrated to a variety of statistics, including Odeans measure of the disposition effect. Our model also predicts several anomalies, including, among others, the flattening of the capital market line and a negative price for idiosyncratic risk. The Author 2012. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

Extrapolative Beliefs in the Cross-Section: What Can We Learn from the Crowds?

Abstract Using novel data from a crowdsourcing platform for ranking stocks, we investigate how investors form expectations about stock returns over the next week. We find that investors extrapolate from stocks’ recent past returns, with more weight on more recent returns, especially when recent returns are negative, salient, or from a dispersed cross-section. Such extrapolative beliefs are stronger among nonprofessionals and large stocks. Moreover, consensus rankings negatively predict returns over the next week, more so among stocks with low institutional ownership and a high degree of extrapolation. A trading strategy that sorts stocks on investor beliefs generates an economically significant profit.

Asset Pricing with Return Extrapolation

We present a new model of asset prices in which the agent has Epstein-Zin preferences and extrapolative beliefs about stock market returns. Unlike earlier return extrapolation models, our model allows for a quantitative comparison with the data on asset prices and expectations. The model generates excess volatility and predictability of stock market returns, a high equity premium, a low and stable risk-free rate, a persistent price-dividend ratio, and a low correlation between stock market returns and consumption growth. Moreover, the agents expectations about future returns depend positively on recent past returns, consistent with survey evidence on return expectations.