Working Paper: CEPR ID: DP17768
Authors: Benjamin Born; Zeno Enders; Manuel Menkhoff; Gernot Müller; Knut Niemann
Abstract: To shed light on the expectation formation of firms, we use firm-level data and examine how expectations adjust to news. We classify news as either micro (firm-specific developments) or macro (information about the aggregate economy). Analyzing survey data from Italian and German firms, we consistently find that expectations overreact to micro news but underreact to macro news. Our empirical specification is based on a stylized model of `island illusion,' because of which firms systematically underestimate the importance of aggregate developments for their own performance. This illusion has aggregate implications, which we derive by embedding it into the canonical noisy-information model.
Keywords: firm expectations; overreaction; underreaction; micro news; macro news; island illusion
JEL Codes: D84; C53; E71
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| micro news (O12) | forecast errors (C53) |
| macro news (E60) | forecast errors (C53) |
| firm expectations (D84) | forecast errors (C53) |
| positive micro news (D78) | negative forecast errors (C53) |
| positive macro news (E60) | positive forecast errors (C53) |