Subjective Risk and Return

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Abstract

I use novel data on subjective risk and return expectations to infer investors’ required returns. I find that the required compensation for risk is high while the realized compensation for risk is low. This difference arises because cash flow forecasts are systematically too high for risky stocks, which can be explained by investors suffering from optimism bias. The weak link between realized and required returns has two important implications: First, most equity factors have a negative required return despite having a positive realized return. Second, recent empirical asset pricing models explain realized returns well but required returns poorly—while the opposite is true for traditional models like the CAPM.
Original languageEnglish
Place of PublicationFrederiksberg
PublisherInstitut for Finansiering, CBS
Number of pages77
Publication statusPublished - 2022
SeriesWorking Papers / Department of Finance. Copenhagen Business School
ISSN0903-0352

Keywords

  • Asset pricing
  • Subjective expectations
  • Equity factors
  • Asset pricing models

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