Heterogeneity in expectations, risk tolerance, and household stock shares: The attenuation puzzle

This paper jointly estimates the relationship between stock share and expectations and risk preferences. The survey allows individual-level, quantitative estimates of risk tolerance and of the perceived mean and variance of stock returns. These estimates have economically and statistically significant association for the distribution of stock shares with relative magnitudes in proportion with the predictions of theories. Incorporating survey measurement error in the estimation model increases the estimated associations twofold, but they are still substantially attenuated being only about 5 percent of what benchmark finance theories predict. Because of the careful attention in the estimation to measurement error, the attenuation likely arises from economic behavior rather than errors in variables.