Over the course of many years, the Gallup survey asks individual investors about their beliefs about the stock market over the next twelve months. We will indicate this future return over the next 12 months as Rt, t+12 The survey was conducted at the beginning of each month, call it t. We can take the average of the forecasts across surveyed subjects and call it the consensus expectation from these subjects of the return from time t to time t+12, Exp[Rt, t+12]: (1) The figure below compares the Gallup survey expectations with flows into equity mutual fund. According to the figure, do you think Gallup survey expectations could reasonably reflect the expectations of the participants? Briefly explain. Your explanation should be based on the patterns in the figure. 80 1.00% Gallup Survey Expectations Flows into Stock Market 0.80% 60-41 Gallup % Bullish - % Bearish 20 20 20 40 40 -40 4. -60 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Figure 4 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 0.60% 0.40% 0.20% 0.00% -0.20% -0.40% -0.60% -0.80% -1.00% Comparing the Gallup survey with flows into equity mutual funds The solid line denotes the percentage of investors who are bullish in the Gallup survey (left axis). The dashed line (right axis) is flows into mutual funds as a percentage of equity market capitalization, as reported by the Investment Company Institute. Flows into Equity Market (2) To explore what determines the forecast of returns, we regress the expectations of future returns on a set of variables as follows: Expt [Rt, t+12] = a + Rt-13, t-1 + Log (Pt/Dt) + Y Z + + &t where Rt-13, t-1 denotes the cumulative returns that occurred over the year prior to the survey, Log (Pt Dt) denotes the log price-dividend ratioa measure of the price-leveland Zt denotes other fundamental variables, such as earnings growth, unemployment and risk-free rate. We run 4 separate regressions, each using one or more of the independent variables specified in the equation. The estimated coefficients are reported in the table below, the numbers in brackets are corresponding t statistics. (1) (2) (4) Dep var: Rt-13,t-1 Gallup Survey Expectation 91.227 89.155 107.759 [8.811] [13.052] [8.544] Log(P/D) 25.995 27.995 [4.107] [2.663] Earnings growth 21.244 -12.482 [2.994] [-1.786] Unemployment 1.346 -2.59 [0.380] [-0.842] Risk-free rate 488.585 -71.38 [1.925] [-0.550] N R2 135 0.611 135 135 135 0.689 0.403 0.718 According to the table, do you think investor's expectations depend more on past returns or more on past fundamental information? Briefly explain. Your explanation should include information from the table.