Investor Memory and Biased Beliefs: Evidence from the Field

We survey a large representative sample of retail investors to elicit their memories of stock market investment and return expectations. We then merge the survey data with administrative data of transactions to test a model in which investors selectively recall past experiences similar to the present cue and use them to form return expectations. Our analysis uncovers new stylized facts about investor memory and provides support for similarity-based recall as a key mechanism of belief formation. We document that market fluctuations affect investors’ recall process: when returns are high, investors tend to retrieve past episodes of rising markets and recall past performances more positively. Retrieved memories, in turn, have large explanatory power for cross-investor variation in beliefs: a single variable based on recalled performance has explanatory power for return expectations similar to that of a dozen individual characteristics combined. Recalled past returns also drive out the explanatory power of realized past returns for expected future returns, which provides a memory-based foundation for return extrapolation behaviors.

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