Knowledge that Transforms

This paper studies the transmission of monetary policy to the stock market through investors’ discount factors. To isolate this channel, we investigate the effect of US monetary policy surprises on the ratio of prices of the same stock listed simultaneously in Hong Kong and Mainland China. We identify a strong discount rate channel driven exclusively by cycle-amplifying surprises, defined as rate cuts during easing cycles and surprise hikes during tightening cycles. A 100 basis point of such cycle-amplifying surprise induces a 30 basis point change in the price ratio within five days.

We document implicit extrapolation in investment decision-making that exceeds the extrapolation inferable from stated expectations. Locally experienced returns predict individual real-estate investment decisions even conditional on an investor’s forecasted home-price growth and risk aversion. Moreover, estimates of this experience effect on investment are larger than implied by the combined effect of past returns on stated expectations and stated expectations on investment. We demonstrate that heterogeneous forecast confidence helps explain why many investors rely on past returns over their survey-elicited forecasts. As their rationale, such survey respondents frequently cite intentional extrapolation or a lack of confidence in other belief factors.

Disagreement about macroeconomic fundamentals accounts for only part of the disagreement about future interest rates, creating a “disagreement correlation” puzzle. This puzzle arises because standard equilibrium models with belief differences predict a strong link between asset return disagreement and fundamental disagreement, a link not supported by the data. We address this puzzle by introducing a model where disagreement about future demand for savings—driven by disagreement over the prevalence of patient versus impatient investors in the economy—generates asset return disagreement. Our mechanism produces stochastic yield volatility, time-varying bond risk premia, and an upward-sloping yield curve. Empirically, we construct a proxy for demand disagreement by isolating the component of yield disagreement unrelated to disagreement about macro-fundamentals. This proxy is positively related to yields and their volatilities, and predicts future bond risk premia, consistent with the predictions of our demand disagreement model.