Past returns and the perceived Sharpe ratio

We find that human perception contradicts the market efficiency assertions that highexpected returns are accompanied by high risk and that past returns are not correlatedwith future returns. A survey of investors reveals that the last month realized returns arepositively correlated with next month perceived returns and that they are negatively correlatedwith perceived risk. Neither expected return nor perceived risk captures the entireeffect. Thus, in the human mind the “perceived Sharpe ratio” is positively correlated withshort-term past returns. The effect does not depend on gender, education, income, andportfolio value, but it is more profound among older investors.