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Noisy Memory and Over-Reaction to News

Author

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  • Rava Azeredo da Silveira
  • Michael Woodford

Abstract

We propose a model of optimal decision-making subject to a memory constraint. The constraint is a limit on the complexity of memory measured using Shannon's mutual information, as in models of rational inattention. We show that the model implies that both forecasts and actions will exhibit idiosyncratic random variation; that beliefs will fluctuate forever around the rational-expectations (perfect-memory) beliefs with a variance that does not fall to zero; and that more recent news will be given disproportionate weight. The model provides a simple explanation for a number of features of expectations in laboratory and field settings.

Suggested Citation

  • Rava Azeredo da Silveira & Michael Woodford, 2019. "Noisy Memory and Over-Reaction to News," AEA Papers and Proceedings, American Economic Association, vol. 109, pages 557-561, May.
  • Handle: RePEc:aea:apandp:v:109:y:2019:p:557-61
    Note: DOI: 10.1257/pandp.20191049
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    References listed on IDEAS

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    1. Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 971-987, December.
    2. Landier, Augustin & Ma, Yueran & Thesmar, David, 2017. "New Experimental Evidence on Expectations Formation," CEPR Discussion Papers 12527, C.E.P.R. Discussion Papers.
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    Cited by:

    1. Besley, Timothy & Fetzer, Thiemo & Mueller, Hannes, 2019. "Terror and Tourism: The Economic Consequences of Media Coverage," CAGE Online Working Paper Series 449, Competitive Advantage in the Global Economy (CAGE).
    2. George-Marios Angeletos & Karthik Sastry, 2019. "Inattentive Economies," NBER Working Papers 26413, National Bureau of Economic Research, Inc.

    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

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