Working Paper: NBER ID: w27947
Authors: Hassan Afrouzi; Spencer Yongwook Kwon; Augustin Landier; Yueran Ma; David Thesmar
Abstract: We study how biases in expectations vary across different settings, through a large-scale randomized experiment where participants forecast stable random processes. The experiment allows us to control the data generating process and the participants’ relevant information sets, so we can cleanly measure forecast biases. We find that forecasts display significant overreaction to the most recent observation. Moreover, overreaction is especially pronounced for less persistent processes and longer forecast horizons. We also find that commonly-used expectations models do not easily account for the variation in overreaction across settings. We provide a theory of expectations formation with imperfect utilization of past information. Our model closely fits the empirical findings.
Keywords: expectations; overreaction; working memory
JEL Codes: C91; D03; D84
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| recent observations (Y50) | forecast biases (C53) |
| less persistent processes (C41) | overreaction in forecasts (G17) |
| longer forecast horizons (C53) | overreaction in forecasts (G17) |
| persistence of the process (C41) | degree of overreaction in forecasts (G17) |
| expectation formation model (D84) | prediction of overreaction (G41) |
| commonly used expectations models (C51) | failure to account for variation in overreaction (G41) |