Thinking about Prices versus Thinking about Returns in Financial Markets

• DOI: http://doi.org/10.1111/jofi.12835
• Published date: 01 December 2019
• Date: 01 December 2019
• Author: ZWETELINA ILIEWA,MARTIN WEBER,MARKUS GLASER

THE JOURNAL OF FINANCE •VOL. LXXIV, NO. 6 •DECEMBER 2019

Thinking about Prices versus Thinking about

Returns in Financial Markets

MARKUS GLASER, ZWETELINA ILIEWA, and MARTIN WEBER∗

ABSTRACT

Prices and returns are alternative ways to present information and to elicit expec-

tations in financial markets. But do investors think of prices and returns in the

same way? We present three studies in which subjects differ in the level of exper-

tise, amount of information, and type of incentive scheme. The results are consistent

across all studies: asking subjects to forecast returns as opposed to prices results in

higher expectations, whereas showing them return charts rather than price charts re-

sults in lower expectations. Experience is not a useful remedy but cognitive reflection

mitigates the impact of format changes.

PRICES AND RETURNS ARE ALTERNATIVE ways to present financial market infor-

mation and to elicit financial market expectations in surveys. According to

normative decision theory, expectations are invariant to superficial changes in

the way the information is presented and the way they are elicited. However,

do investors understand a chart of a fund’s performance in the same way

when the performance chart plots past prices or past returns? And is it

the same to ask an analyst to forecast prices or returns? In this paper, we

separate the impact the chart format and the question format have in a 2×2

between-subject design, and compare the format of prices and returns in three

∗Markus Glaser is at the Institute for Capital Markets and Corporate Finance, Ludwig-

Maximilians-University Munich. Zwetelina Iliewa (corresponding author) is at the Max Planck

Institute for Research on Collective Goods (email: iliewa@coll.mpg.de). Martin Weber is in the De-

partment of Banking and Finance, University of Mannheim, and the Centre for Economic Policy

Research. We are grateful to Wei Xiong (the Editor), an anonymous Associate Editor, two anony-

mous referees, as well as Peter Bossaerts, Edgar Erdfelder, Ben Greiner, Arvid Hoffmann, Lena

Jaroszek, Markku Kaustia, Christine Laudenbach, Christoph Merkle, Alexandra Niessen-Ruenzi,

Terrance Odean, Jesper Riedler, Martin Schmalz, Paul Smeets, Michael Ungeheuer, and Qingwei

Wang for helpful suggestions. Wealso thank seminar participants at the University of Mannheim,

University of Strasbourg, the Centre for Financial Research (Cologne), and the National Academy

of Sciences Leopoldina, as well as conference participants at the Experimental Finance Conference

2016, the Research in Behavioral Finance Conference 2016, the Paris December 2016 Finance

Meeting, the 2017 AFA Annual Meeting, the 2017 Boulder Summer Conference on Consumer Fi-

nancial Decision Making, and the 2017 WU Gutmann Symposium. The major parts of the work

were conducted while Zwetelina Iliewa was at the Centre for European Economic Research (ZEW).

Preliminary results of Study 3 were previously circulated under the title “Expert Forecasts: Fast,

Frugal, Flawed.” We gratefully acknowledge financial support by the German Research Founda-

tion (DFG), research grants GL695/3-1, SCHR709/4-1, and WE993/15-1. The authors do not have

any potential conflicts of interest to disclose as identified in the Journal of Finance’s disclosure

policy.

DOI: 10.1111/jofi.12835

C2019 the American Finance Association

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2998 The Journal of Finance R

experimental studies. Across the studies, we vary the level of expertise, the

amount of information, and the incentives schemes. We report sizeable and

robust differences in the subjective expectations depending on the format

of the chart and the question: First, asking subjects to forecast returns as

opposed to prices results in higher expectations. The magnitude of the effect

varies between 1.1 and 2.4 percentage points per month across our studies.

In contrast, showing subjects return bar charts as opposed to price line charts

results in lower expectations. Across our studies, the magnitude of the effect

varies between 1.7 and 1.0 percentage points per month. In this paper, we

document and explain the impact of format changes on expectations.

Examining the difference between the price and return formats is important

as they are used extensively in the real world and are often used for the same

purpose. For instance, the information documents of different mutual funds

largely differ in the charts they contain, although they target the same group—

investors. Returns are the mandatory chart format for regulated mandatory

investor information documents in Europe (i.e., Key Investors Information Doc-

ument) and in the United States (i.e., mutual fund prospectus). In contrast, the

optional and unregulated factsheets of funds contain various chart formats.

Analogously, real-world surveys contain both questions about expected prices

and about expected returns. For instance, the Duke/CFO Magazine Business

Outlook Survey elicits expected returns, whereas the Livingston Survey of the

Federal Reserve Bank of Philadelphia asks about expected price levels. More-

over, market participants are generally exposed to patterns in the use of prices

and returns that are hard to explain. For instance, financial websites and var-

ious financial information platforms most often use price charts to plot the

development of a market index but are more likely to use return charts to plot

the development of a passive fund that tracks the market index. Finally,the use

of the price and return formats changes over time due to regulatory changes.

Against this backdrop, it is important to understand how and why investors’

expectations are affected by format differences and format changes they face.

Several previous studies, which we discuss in greater detail below, examine

how the formats of prices and returns affect subjective expectations. However,

they present mixed results, which may be due to differences in study design.

For instance, Diacon and Hasseldine (2007) and St¨

ossel and Meier (2015) focus

on the effect of the chart format and a mixture of chart formats by holding the

question format constant, while Glaser et al. (2007) examine the effect of the

question format by holding the chart format constant. Our main contributions

to this literature are as follows. First, we resolve the apparent contradictions

offered by previous studies by separating the effect of the chart format (i.e.,

return bar chart vs. price line chart) from the effect of the question format

(i.e., expected price vs. expected return). For this purpose, in two laboratory

studies we vary the format of the chart and the format of the question in a 2×2

between-subject design. Second, we test the boundaries of subjects’ susceptibil-

ity to format changes by testing it under different conditions: different levels

of expertise and experience (i.e., students in the lab vs. finance professionals),

different amounts of information (i.e., historical charts only vs. real-world

Thinking about Prices vs. Thinking about Returns in Financial Markets 2999

information), and different incentive schemes (i.e., fixed vs. performance-

based). Third, we distinguish between potential explanations of how the ques-

tion and chart formats affect investors’ expectations. Fourth, we isolate the

impact of the chart format from potential confounding factors, which may

have influenced the results in previous studies, such as the data frequency of

the chart.

Our further results can be summarized as follows. We show that the sizeable

effects of the chart and question formats are not mitigated by performance-

based incentives, expertise, or real-world information. In addition, we show

that neither dividend yield, nor risk premium or the use of simple heuristics

can explain our findings. We find, however, that the chart and question formats

have a larger effect if subjects score low on cognitive reflection, which indicates

that they tend to rely on their intuition rather than reflecting upon their

answers. We identify several characteristics of the intuitive number sense

that can jointly explain our findings. Furthermore, the formats of prices and

returns also draw attention to different episodes of the past. When subjects

are shown price line charts, they extrapolate only from the most recent past.

In contrast, when they are shown return charts and asked to forecast returns,

they take the entire available past information into account.

Our results imply that the format design in financial markets can be used as a

powerful tool to alter investors’ expectations. Information platforms and finan-

cial advisors could thus either willingly or unwillingly manipulate investors’

expectations by varying the format through which their investors perceive

the past and think about the future. Understanding how the information pre-

sentation affects investors is of the utmost importance considering the rising

importance of automated robo advisors. They are set out to replace the human

advisors by providing unbiased and accessible financial advice, especially to

less wealthy investors (e.g., Financial Conduct Authority (2016)). Robo advisors

only “communicate” with their clients by means of quantitative and graphical

information. Understanding how format changes contribute to their clients’

perception of the information is therefore crucial for the success of their advice.

Our results also imply that the regulation of the way financial information is

presented has the potential to alter the way people think about financial assets.

The remainder of this paper proceeds as follows. Section Iprovides a field

overview of the use of prices and returns. In Section II, we describe the

experimental design of the three studies. In Section III, we present our results

on the differences between the two chart and question formats. In Section IV,

we discuss potential explanations. In Section V, we provide evidence on how

the different formats draw investors’ attention to different episodes of the

past. In Section VI, we examine how the chart and question formats affect the

forecast accuracy. In Section VII, we conclude.

I. The Use of Prices and Returns in the Field

Prices and returns are alternative ways to present information on the

development of financial assets and to elicit financial expectations. But are