We investigate whether individuals' experiences of macroeconomic outcomes have long-term effects on their risk attitudes, as often suggested for the generation that experienced the Great Depression. Using data from the Survey of Consumer Finances from 1964-2004, we find that individuals who have experienced low stock-market returns throughout their lives report lower willingness to take financial risk, are less likely to participate in the stock market, and, conditional on participating, invest a lower fraction of their liquid assets in stocks. Individuals who have experienced low bond returns are less likely to own bonds. All results are estimated controlling for age, year effects, and a broad set of household characteristics. Our estimates indicate that more recent return experiences have stronger effects, but experiences early in life still have significant influence, even several decades later. Our results can explain, for example, the relatively low stock-market participation of young households in the early 1980s, following the disappointing stock-market returns in the 1970s, and the relatively high participation of young investors in the late 1990s, following the boom years in the 1990s. In the aggregate, investors' lifetime stock-market return experiences predict aggregate stock-price dynamics as captured by the price-earnings ratio.

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This paper documents that carry traders are subject to crash risk: i.e. exchange rate movements between high-interest-rate and low-interest-rate currencies are negatively skewed. We argue that this negative skewness is due to sudden unwinding of carry trades, which tend to occur in periods in which risk appetite and funding liquidity decrease. Funding liquidity measures predict exchange rate movements, and controlling for liquidity helps explain the uncovered interest-rate puzzle. Carry-trade losses reduce future crash risk, but increase the price of crash risk. We also document excess co-movement among currencies with similar interest rate. Our findings are consistent with a model in which carry traders are subject to funding liquidity constraints.

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This paper documents that hedge funds did not exert a correcting force on stock prices during the technology bubble. Instead, they were heavily invested in technology stocks. This does not seem to be the result of unawareness of the bubble: Hedge funds captured the upturn, but, by reducing their positions in stocks that were about to decline, avoided much of the downturn. Our findings question the efficient markets notion that rational speculators always stabilize prices. They are consistent with models in which rational investors may prefer to ride bubbles because of predictable investor sentiment and limits to arbitrage.TECHNOLOGY STOCKS ON NASDAQ ROSE to unprecedented levels during the 2 years leading up to March 2000. Ofek and Richardson (2002) estimate that at the peak, the entire internet sector, comprising several hundred stocks, was priced as if the average future earnings growth rate across all these firms would exceed the growth rates experienced by some of the fastest growing individual firms in the past, and, at the same time, the required rate of return would be 0% for the next few decades. By almost any standard, these valuation levels are so extreme that this period appears to be another episode in the history of asset price bubbles.Shiller (2000) argues that the stock price increase was driven by irrational euphoria among individual investors, fed by an emphatic media, which maximized TV ratings and catered to investor demand for pseudonews. Of course, only few economists doubt that there are both rational and irrational market participants. However, there are two opposing views about whether rational traders correct the price impact of behavioral traders. Proponents of the * Markus K. Brunnermeier is affiliated with Princeton University and CEPR and Stefan Nagel with Stanford University. We would like to thank Cliff Asness, Richard Brealey, Smita Brunnermeier, Elroy Dimson, Gene Fama, Bill Fung, Rick Green (the editor), Martin Gruber, Tim Johnson, Jon Lewellen, Andrew Lo, Burt Malkiel, Narayan Naik, Aureo de Paula, Lukasz Pomorski, Jeff Wurgler, and two anonymous referees as well as participants at the European Finance Association Meetings, the Fall 2002 NBER Behavioral Finance Meetings, and in seminars at the Board of Governors of the Federal Reserve System, Federal Reserve Bank of New York, University of Chicago, London Business School, MIT, Northwestern University and Princeton University for useful comments. Part of this research was undertaken while both authors were visiting the Sloan School of Management at MIT and while Nagel was a doctoral student at London Business School. Brunnermeier acknowledges research support from the National Science Foundation (NSF-Grant no. 021-4445). Nagel is grateful for financial support from the ESRC, the Lloyd's Tercentenary Foundation, the Kaplanis Fellowship, and the Centre for Hedge Fund Research and Education at London Business School. 2014The Journal of Finance efficient markets hypothesis (Friedman (1953), Fama (1965) argue that rational sp...