Experience Effects Explain Five Facts about Beliefs and Portfolios

Abstract: Giglio et al. (2021) uncover a series of regular features related to financial investors’ beliefs and portfolios; this paper proposes a model that incorporates these features. In our model, investors trade infrequently, and when forming expectations, they overweigh the information of previous periods when they traded. As a result, our cross-section of traders contains pessimists (optimists) who recall bear (bull) markets, as well as the youth (elderly) who have fewer (more) data points in their samples. As required by Giglio et al. (2021), expected returns and the subjective probability of rare disasters are negatively related in our model.