Evidence from the laboratory and the field has uncovered both underreaction and overreaction to new information. We provide new experimental evidence on the underlying mechanisms of under‐ and overreaction by comparing how people make inferences and revise forecasts in the same information environment. Participants underreact to signals when inferring about underlying states, but overreact to the same signals when revising forecasts about future outcomes—a phenomenon we term “the inference‐forecast gap.” We show that this gap is largely driven by different simplifying heuristics used in the two tasks. Additional treatments suggest that the choice of heuristics is affected by the similarity between statistics in the information environment and the statistic elicited by the belief‐updating problem.

Abstract We propose an extrapolative model of bubbles to explain the sharp rise in prices and volume observed in historical financial bubbles. The model generates a novel mechanism for volume: because of the interaction between extrapolative beliefs and disposition effects, investors are quick to not only buy assets with positive past returns but also sell them if good returns continue. Using account-level transaction data on the 2014–2015 Chinese stock market bubble, we test and confirm the model’s predictions about trading volume. We quantify the magnitude of the proposed mechanism and show that it can increase trading volume by another 30%.

We survey thousands of affluent American investors to examine the relationship between personalities and investment decisions. The Big Five personality traits correlate with investors' beliefs about the stock market and economy, risk preferences, and social interaction tendencies. Two personality traits, Neuroticism and Openness, stand out in their explanatory power for equity investments. Investors with high Neuroticism and those with low Openness tend to allocate less investment to equities. We examine the underlying mechanisms and find evidence for both standard channels of preferences and beliefs and other nonstandard channels. We show consistent out-of-sample evidence in representative panels of Australian and German households.

Abstract When members of the same household have different risk preferences, whose preference matters more for investment decisions and why? We propose an intrahousehold model that aggregates individual preferences at the household level as a result of bargaining. We structurally estimate the model, analyze the determinants of bargaining power, and find a significant gender gap. Gender differences in individual characteristics, as well as gender effects, partially explain the gap. These patterns hold broadly across Australia, Germany, and the United States. We further link the distribution of bargaining power to households’ perceived gender norms in a cross-sectional analysis. (JEL G11, G41, G50)

Abstract Existing research finds that investors’ returns vary with their wealth and level of sophistication. We bring a new perspective from the supply side by showing that return heterogeneity can be magnified as assets offered by the market become more complex. Using detailed account-level data, we examine the trading of B funds—complex, structured products in the Chinese market. During a 3-year market cycle, the return gap between the naive and sophisticated is an order-of-magnitude greater when trading B funds than when trading simple, non-structured funds. In an event study, we confirm that this disparity is driven by differences in investors’ understanding of product complexity.

The literature has documented “reaching for yield”—the phenomenon of investing more in risky assets when interest rates drop—among institutional investors. We analyze detailed transaction data from a large brokerage firm to provide direct field evidence that individual investors also exhibit this behavior. Consistent with models of portfolio choice with labor income, reaching for yield is more pronounced among younger and less-wealthy individuals. Consistent with prospect theory, reaching for yield is more pronounced when investors are trading at a loss. Finally, we observe and discuss the phenomenon of “reverse reaching for yield.”

The success of behavioral economics has led to a new challenge: many biases offer observationally similar predictions for a targeted financial anomaly. To tame this bias zoo, we combine subjective survey responses with observational data to propose a new approach, one that is robust to question-specific biases introduced through surveys. We illustrate this approach by administering a nationwide survey of Chinese retail investors to elicit their trading motives. In cross-sectional regressions of respondents’ actual turnover on survey-based trading motives, perceived information advantage and gambling preference dominate other motives, though they are not the most prevalent biases based on survey responses.

Abstract We survey a large, representative sample of retail investors in China to elicit their memories of stock market investments and their return expectations. We merge these survey data with administrative transaction data to test a model in which investors selectively recall past experiences to form their beliefs. Our analysis uncovers new facts about investor memory and highlights similarity-based recall as a key mechanism of belief formation in financial markets. A rising market prompts investors to recall their past experiences more positively, leading to more optimistic forecasts of future returns. Recalled experiences can explain cross-investor variation in return expectations and, in our setting, dominate actual experiences in their explanatory power. In the transaction data, we confirm that recalled experiences are reflected in investors’ trading decisions through a belief channel.