Abstract
The empirical finance literature documents a puzzling phenomenon: investors tend to adjust their portfolios insufficiently in response to changes in their own forecasts of asset returns. This paper proposes an investment experiment with information treatments to better understand the mechanisms behind this puzzle. The findings suggest that the information available to participants and how they perceive it not only influence the way they form forecasts but also affect how they incorporate these forecasts into their investment decisions. First, the paper shows that participants are less/no longer biased in their forecasts—meaning they no longer rely on past performance—when they believe that the information provided is “useful” for predicting returns. Second, when participants perceive the information as useful, they rely significantly more on their forecasts when making portfolio allocations. In terms of wealth accumulation, the fact that subjects have access to information and find it useful helps to increase their portfolio returns. Educating participants on how to effectively use information could help them make better use of it in their forecasting and improve their portfolio performance. These findings underscore the important role that financial intermediaries can play as providers of advice and information, and highlight their potentially significant impact on investor wealth, particularly for retail investors.
Keywords: Return Predictability, Expectations, Long-Term Investment, Extrapolation, Model Uncertainty
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