Beliefs and Portfolios : Causal Evidence

We causally test alternative theories of expectation formation and asset pricing. Using a randomized information experiment we show: i) individuals form pro-cyclical beliefs, both about capital gains and about earnings growth, inconsistent with rational expectations models; ii) individuals are heterogeneous both at the information acquisition and at the information processing stage. Their reaction to stock-market news depends on their information preference; iii) beliefs and portfolio decisions are causally linked; iv) the sensitivity of portfolio shares with respect to expected returns is low, especially when accounting for individuals’ low perceived variance of stock returns. Non-linear constraints on individuals’ portfolio decisions resolve this puzzle. These results provide guidance on promising causal mechanisms for macro-finance models