Katrin Gödker (Bocconi University): Mental Models about Financial Markets: How Do Experts Reason About Pricing?

Abstract:
We explore how subjective models of pricing in financial markets influence return expectations. What we do: we measure subjective models & document a causal effect on return expectations. 1) We provide evidence from finance experts: we use an expert survey among financial professionals. 2) Application to climate risks: we measure these subjective models about pricing i) in general and ii) applied to climate risk. 3) Emphasis on beliefs about other market participants’ beliefs (second-order beliefs): we provide rich empirical evidence on the important role of second-order beliefs for pricing views and return expectations.

What we find: We document large disagreement among experts in  how they reason about climate risks and the pricing of those risks. This reasoning explains return expectations. Second-order beliefs are important in experts’ views about pricing. Second-order beliefs causally affect return expectations.