Essays in Experiences and Household Finance

My dissertation studies how experiences of asset markets during the lifetime of household heads affect the households' financial decisions. According to traditional theory, these experiences should not play an important role because rational investors should consider all the available information regarding the markets and should not pay particular attention to their personal experiences. However, I show that different experiences in the stock or the housing markets during the lifetime of a household head imply different investment decisions of the household in each of these markets. Moreover, I present evidence that this behavior impacts asset prices.;The first chapter, titled "Lifetime Experience of Volatility: A New Determinant of Household Demand for Stocks," examines how experiences of volatility during the lifetime of a household head affects the household's financial risk taking. I show that American household heads that experienced higher stock market volatility during their lifetimes are less likely to participate in the stock market, and invest a lower fraction of their liquid assets in stocks when they do participate. Conversely, those household heads that experienced higher excess returns or Sharpe ratios are more likely to participate in the stock market and invest a higher share of their liquid assets in stocks conditional on participation. My evidence suggests that experiences of the trade-off between excess returns and volatility in the stock market influence investors' portfolio choices by way of their beliefs, rather than preferences. The results in this chapter are consistent with traditional portfolio choice models modified to allow households to form beliefs based, at least in part, on lifetime experiences.;The second chapter, titled "Experienced Returns and Real Estate," focuses on the households' decisions in the real estate market instead of the stock market. First, I show that American household heads' experiences of returns in the housing market during their lifetimes are positively correlated with the fraction of their total assets invested in real estate. Second, I report that the correlation becomes stronger if I estimate the same model within those households that hold some real estate as an investment, i.e. non-residential real estate. Finally, I show that homeowners are more likely to believe that it is not a good time to sell a house when they have experienced higher returns on the housing market during their lifetimes. Taken together, these results highlight the importance of returns experiences for formation of beliefs regarding future housing returns and, consequently, for household real estate investment decisions.;The third chapter, titled "Households' Experiences and Asset Prices," builds on the results in the first chapter to show that population average experiences of excess returns and volatility impact asset prices. On one hand, the time series of the household sector's experiences of excess returns is positively correlated with the valuation ratios of the aggregate stock market and negatively forecasts annual excess returns, particularly at longer time horizons. On the other hand, the time series of the household sector's experiences of volatility exhibits the opposite correlations: it is negatively correlated with the valuation ratios of the aggregate stock market, even after controlling for business cycle covariates and experienced excess returns; and it positively forecasts annual excess returns. The results for experiences of volatility are statistically more robust and theoretically sounder than the results for experiences of excess returns, which suffer from mechanical inverse causality with the valuation ratios.;Overall, my dissertation provides empirical evidence that households extrapolate their lifetime experiences to form their beliefs about future returns. The first two chapters present micro-econometric evidence that experiences affect financial decisions and beliefs of the households across two different asset classes. The last chapter shows asset pricing results that are consistent with households that form their beliefs about the future of the stock market based, at least in part, on their lifetime experiences.