CFA Institute Journal Review summarizes "Socioeconomic Status and Macroeconomic Expectations," by Sreyoshi Das, Camelia M. Kuhnen, and Stefan Nagel, published in Review of Financial Studies, January 2020.
Education and income level affect macroeconomic expectations and choices. People whose socioeconomic status (SES) is higher tend to be more optimistic about future macroeconomic conditions, such as the economy, business conditions, stock market returns, and the unemployment rate, and are more likely to invest in the stock market. The difference between expectations for high- and low-SES groups varies and is pro-cyclical, becoming almost negligible during recessions.
What Is the Investment Issue?
People make economic decisions, such as investing, saving, and consuming, based on what they expect to happen in the future. Rational expectation models, which assume full information and rational, utility-maximizing agents, generally do not deliver diverse macroeconomic expectations. This study examines whether socioeconomic status (SES), as measured by income level and formal education, is associated with differences in macroeconomic expectations and economic decisions.
How Did the Authors Conduct This Research?
For their empirical analysis, the authors use monthly data spanning 1978 to 2014 from the Michigan Survey of Consumers. Macro belief variables include the survey respondents’ subjective probability that the US stock market will perform well over the next year, expectations about the economy and unemployment rate over the next year, and expectations of business conditions over the next one and five years. Supplemental variables track individuals’ investment in stock markets, share of income in stock markets, and attitude toward buying a home, durable goods, or cars.
The authors use income and formal education as tangible measures for SES and the Survey of Professional Forecasters as the benchmark forecast. To conceptualize an aggregate measure of macroeconomic optimism, the authors average the standardized individual beliefs.
In analyzing the data, the authors first run regressions with the SES factors as independent variables and macroeconomic expectations as the dependent variable. They primarily use ordinary least squares regressions, augmented by analysis with recession data, interactions, and fixed effects for categorical variables such as gender and age.
Next, the authors run regressions to quantify the effect of SES on economic choices relating to stock market investment, share of income invested in equities, and attitude toward buying a home, durable goods, or cars. Using standard statistical mediation analysis, they measure the indirect effects of SES as well as the direct and indirect interaction effects of the other factors.
To evaluate the economic significance of the regression results, the authors examine cross-sectional variation in the SES variables and business-cycle-related variation in the macroeconomic belief variables. They also test alternative factors affecting SES expectations. Lastly, they use Bayesian probabilities to investigate three behavioral theories—confirmation bias, local thinking, and a misperception of informativeness of public signals—for low-SES pessimism.
What Are the Findings and Implications for Investors and Investment Professionals?
The results offer three main findings. First, income and formal education shape people’s macroeconomic expectations. Higher earners who have a college degree maintain more optimistic macroeconomic beliefs, and the results indicate that SES is a cause of these beliefs rather than an effect. For instance, individuals with a college degree believe the chance of the stock market doing well is 7.2% higher compared with the belief of their less formally educated peers.
Second, the difference in beliefs between high- and low-SES individuals is positively correlated with business cycles and is almost negligible during recessions. In other words, when times are bad, optimism declines for everyone, regardless of SES.
And finally, low-SES individuals are more pessimistic and make less accurate economic forecasts than high-SES individuals. Cross-sectional analysis shows that SES-related differences in expectations are statistically and economically significant. Households with lower income and less formal education are less likely to participate in the stock market. The authors state that the pro-cyclical, optimistic beliefs of high-SES individuals with regard to stock market returns might mean that these investors mis-time the market; the authors offer this as a potential avenue for further research.