This study uses data that offers the unique opportunity to analyze how an unprecedented crisis suchas the September 11 tragedy influences expected returns and volatility forecasts of individual investors. Via e-mail, we asked a randomly selected group of individual investors with accounts at a German online broker to answer an internet questionnaire at the beginning of August 2001. A second e-mail to the investors who had not yet answered, scheduled five weeks later, was postponed due to the terror attacks until September 20, which was exactly the day with the lowest share prices in Germany in the year 2001. Based on the answers to questions concerning stock market predictions, we find that return forecasts of the investors in our sample are significantly higher after September 11, suggesting a belief in mean reversion. Our results show that investors interpret the largedrop in share prices during the ten day period after September 11 mainly as temporary rather than permanent. After the terror attacks, volatility forecasts are higher than before September 11. In two out of four cases, historical volatilities are overestimated. Therefore, investors are not generally overconfident in the way that they underestimate the variance of stock returns. Differences of opinion with regard to return forecasts are lower after the terror attacks whereas differences of opinion concerning volatility forecasts are mainly unaffected.

This article investigates two research questions: do investors see a relationship between risk attitude and the amount invested into risky assets? Further, do investors adjust their investments if provided with assets that have different volatilities? In an experimental study, investors allocate an amount between a risky and a risk-free asset. Investors’ risk attitude predicts risk taking. Investors are, however, unable to adapt to risky assets with different volatilities; they choose almost the same allocation to the risky asset independently of its volatility, thus amassing significantly different portfolios.

The more trust investors place in a money manager, the more confident they are to take risk. We test this theory in a laboratory experiment using the amount returned from a trust game as measure of trustworthiness. Investors increase the share invested in risky assets with high-cost money managers compared to those with low costs when the high-cost money managers are more trustworthy than the low-cost ones. The willingness to take more risk with high-cost money managers is increasing in the difference in trustworthiness. Up to a third of the difference in trustworthiness translates into an increasing risky share. Vice versa, investors are willing to accept higher costs for investments made through more trustworthy money managers. Our findings are robust to alternative explanations, demonstrating that the risk-aversion channel can be sufficient for trust to influence behavior.

Exploiting regional holidays in Germany as a source of exogenous cross-sectional variation in investor attention, we provide evidence that the well-known local bias at the individual level materially affects stock turnover at the firm level. Stocks of firms located in holiday regions are temporarily strikingly less traded than otherwise very similar stocks in non-holiday regions. This negative turnover shock survives comprehensive tests for differences in information release. It appears particularly pronounced in stocks less visible to nonlocal investors and for smaller stocks disproportionately driven by retail investors. Our findings contribute to research on local bias, trading activity, and investor distraction.

Return-chasing investors almost exclusively consider top-performing funds for their investment decisions. When drawing conclusions about the managerial skill of these top performers, they tend to neglect fund volatility and the cross-sectional information contained in the number of funds and the distribution of skill. In multiple surveys of sophisticated retail investors, we show that they do not fully understand the role of chance in experimental samples of fund populations. Respondents evaluate each fund in isolation and do not sufficiently account for fund volatility. They confuse risk taking with manager skill and are thus likely to over-allocate capital to lucky past winners.

It is a long-standing fact that households mostly consume and rarely reinvest dividends. Among representative brokerage clients of one of Germany’s largest banks, we find the opposite: 80 percent reinvestments and 12 percent consumption. Of these reinvestments, the majority occurs with a delay after dividends are initially parked as brokerage cash. Motivated by this finding, we study payout modalities (deposits into brokerage accounts, checking accounts, or checks) as a novel mechanism that nudges investors toward reinvesting or consuming dividends. Consistent with a transition from checks to brokerage deposits, we find that the dividend consumption rate in the Consumer Expenditure Survey has decreased substantially over time.

Between September 08 and June 09, a period with significant market events, we surveyed UK online-brokerage customers at 3-month intervals for their willingness to take risk, 3-month expectations of returns and risks for the market and their own portfolio, and self-reported risk attitude. This unique dataset allowed us to analyze how these variables changed over time, and whether changes in risk taking were related to changes in expectations and/or risk attitudes. Risk taking changed substantially during the period, as did return and risk expectations. Numeric assessments of return and risk expectations were only weakly correlated with corresponding subjective judgments. Consistent with the risk-as-feelings hypothesis, changes in risk taking were associated with changes in subjective expectations of market portfolio risk and returns, but less with changes in numeric expectations.

Studies analyzing return expectations of financial market participants like fund managers, CFOs or individual investors are highly influential in academia and practice. We argue and show that the results in these surveys above are easily influenced by the elicitation mode of return expectations. Surveys that ask for future stock price levels are more likely to produce mean reverting expectations than surveys that directly ask for future returns. Furthermore, we conduct a questionnaire study that explicitly analyzes whether the specific elicitation mode affects return expectations in the above direction. In our study, subjects were asked to state mean forecasts for seven time series. Using a between subject design, one half of the subjects was asked to state future price levels, the other group was directly asked for returns. We observe a highly significant framing effect. For upward sloping time series, the return forecasts stated by investors in the return forecast mode are significantly higher than those derived for investors in the price forecast mode. For downward sloping time series, the return forecasts given by investors in the return forecast mode are significantly lower than those derived for investors in the price forecast mode. We argue that this finding is consistent with behavioral theories of investor expectation formation based on the representativeness heuristic.

An increasing number of studies depart from the rational expectations assumption to reconcile survey expectations with asset prices. While surveys are helpful to establish a link between subjective beliefs and investment decisions, precise inference about how investors depart from rational expectations can be challenging without relying on strong assumptions. In this article, we provide direct experimental evidence of how systematic distortions in investors’ expectations affect their risk-taking across market cycles. As mechanism, we identify an asymmetry in how individuals update their expectations across boom and bust markets. The documented mechanism is consistent with survey data and provides important implications for recently proposed asset pricing models.