The perception of dependence, investment decisions, and stock prices


Ungeheuer, Michael ; Weber, Martin



DOI: https://doi.org/10.1111/jofi.12993
URL: https://onlinelibrary.wiley.com/doi/abs/10.1111/jo...
Additional URL: https://papers.ssrn.com/sol3/papers.cfm?abstract_i...
Document Type: Article
Year of publication Online: 2020
The title of a journal, publication series: The Journal of Finance
Volume: tba
Page range: tba
Place of publication: Hoboken, NJ [u.a.]
Publishing house: Wiley
ISSN: 0022-1082 , 1540-6261
Publication language: English
Institution: Business School > ABWL u. Bankbetriebslehre (Seniorprofessur) (Weber 2017-)
Subject: 330 Economics
Classification: JEL: C91, G02, G11, G12,
Keywords (English): Asset Pricing, Biased Beliefs, Correlation Neglect, Dependence, Diversification, Investment Decisions
Abstract: We study how investors perceive dependence between stock returns, how this influences investment decisions and stock prices. Our findings suggest that investors understand differences in dependence, but correlation does not properly capture their perception of dependence. In several laboratory experiments, we show that subjects understand dependence in frequent, moderate returns, but do not understand dependence in infrequent, extreme returns. Consistent with a counting heuristic, they diversify more at lower frequencies of comovement, even if correlation increases due to strong positive dependence in extreme returns. Applying our insights from experiments to 1963-2015 US stock returns, we find that there is a robust return premium for stocks with high frequencies of comovement with the market return. Our findings suggest that dependence between stock returns matters for investors and aggregate market outcomes. They also suggest that investors could improve portfolio selection by taking into account biased beliefs about dependence.

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