Predictability in Financial Markets: What Do Survey Expectations Tell Us?

There is widespread evidence of excess return predictability in financial markets. A potential explanation is that investors make expectational errors that are predictable. To examine this issue, we use data on survey expectations of market participants in the stock market, the foreign exchange market, and the bond and money markets in various countries. We find systematic evidence of predictable expectational errors across markets, sample periods and countries. Moreover, the predictability of expectational errors coincides with the predictability of excess returns: when a variable predicts expectational errors in a given market, it typically predicts the excess return as well. We conclude that that predictable expectational errors play a key role in understanding excess return predictability.