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Optimally Imprecise Memory and Biased Forecasts

Author

Listed:
  • Rava Azeredo da Silveira
  • Yeji Sung
  • Michael Woodford

Abstract

We propose a model of optimal decision-making subject to a memory constraint in the spirit of models of rational inattention. Our theory differs from that of Sims (2003) in not assuming costless memory of past cognitive states. The model implies that both forecasts and actions will exhibit idiosyncratic random variation; that average beliefs will exhibit a bias that fluctuates forever; and that more recent news will be given disproportionate weight in forecasts. The model provides a simple explanation for the overreaction to news observed in the laboratory by Afrouzi et al. (2023).

Suggested Citation

  • Rava Azeredo da Silveira & Yeji Sung & Michael Woodford, 2024. "Optimally Imprecise Memory and Biased Forecasts," American Economic Review, American Economic Association, vol. 114(10), pages 3075-3118, October.
    • Handle: RePEc:aea:aecrev:v:114:y:2024:i:10:p:3075-3118
    DOI: 10.1257/aer.20201806
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    More about this item

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets

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