Recovering Investor Expectations from Demand for Index Funds

Mark  Egan; Alexander J. MacKay; Hanbin  Yang

Working Paper | HBS Working Paper Series | 2020

Recovering Investor Expectations from Demand for Index Funds

by Mark Egan, Alexander J. MacKay and Hanbin Yang

Abstract

We use a revealed-preference approach to estimate investor expectations of stock market returns. Using data on demand for index funds that follow the S&P 500, we develop and estimate a model of investor choice to flexibly recover the time-varying distribution of expected returns. Our analysis is facilitated by the prevalence of “leveraged” funds that track the same underlying asset: by choosing between higher and lower leverage, investors trade off higher return against less risk. Although generated from a different method (realized choices) and a different population, our quarterly estimates of investor expectations are positively and significantly correlated with the leading surveys used to measure stock market expectations. Our estimates suggest that investor expectations are heterogeneous, extrapolative, and persistent. Following a downturn, investors become more pessimistic on average, but there is also an increase in disagreement among participating investors.

Keywords: stock market expectations; demand estimation; exchange-traded funds (ETFs); Demand and Consumers; Investment; United States;

Language: English

Format: Print

74 pages

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Citation:

Egan, Mark, Alexander J. MacKay, and Hanbin Yang. "Recovering Investor Expectations from Demand for Index Funds." NBER Working Paper Series, No. 26608, January 2020. (Direct download. Harvard Business School Working Paper, No. 20-122, May 2020)

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Recovering Investor Expectations from Demand for Index Funds

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