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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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    File URL: https://www.aeaweb.org/doi/10.1257/pandp.20191049
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    Cited by:

    1. Galanis, Giorgos & Kollias, Iraklis & Leventidis, Ioanis & Lustenhouwer, Joep, 2022. "Generalizing Heterogeneous Dynamic Heuristic Selection," CRETA Online Discussion Paper Series 73, Centre for Research in Economic Theory and its Applications CRETA.
    2. Benjamin Enke & Thomas Graeber, 2019. "Cognitive Uncertainty," NBER Working Papers 26518, National Bureau of Economic Research, Inc.
    3. Neligh, Nathaniel, 2024. "Rational memory with decay," Journal of Economic Behavior & Organization, Elsevier, vol. 223(C), pages 120-145.
    4. Timothy Besley & Thiemo Fetzer & Hannes Mueller, 2023. "How Big Is the Media Multiplier? Evidence from Dyadic News Data," CESifo Working Paper Series 10619, CESifo.
    5. Chen Lian, 2021. "Mistakes in Future Consumption, High MPCs Now," NBER Working Papers 29517, National Bureau of Economic Research, Inc.
    6. Chahrour, Ryan & Jurado, Kyle, 2021. "Optimal foresight," Journal of Monetary Economics, Elsevier, vol. 118(C), pages 245-259.
    7. Caballero, Adrián & López-Pérez, Raúl, 2022. "Heterogeneous primacy and recency effects in frequency estimation," Journal of Economic Behavior & Organization, Elsevier, vol. 200(C), pages 182-203.
    8. 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).
    9. George-Marios Angeletos & Karthik A. Sastry, 2025. "Inattentive Economies," Journal of Political Economy, University of Chicago Press, vol. 133(7), pages 2265-2319.
    10. Galanis, Giorgos & Kollias, Iraklis & Leventidis, Ioanis & Lustenhouwer, Joep, 2022. "Generalizing Heuristic Switching Models," Working Papers 0715, University of Heidelberg, Department of Economics.
    11. Xie, Erhao, 2021. "Empirical properties and identification of adaptive learning models in behavioral game theory," Journal of Economic Behavior & Organization, Elsevier, vol. 191(C), pages 798-821.
    12. Galanis, Giorgos & Kollias, Iraklis & Leventides, Ioanis & Lustenhouwer, Joep, 2025. "Generalizing heuristic switching models and a (boundedly) rational route away from randomness," Journal of Economic Dynamics and Control, Elsevier, vol. 177(C).
    13. Chen Lian, 2023. "Mistakes in Future Consumption, High MPCs Now," American Economic Review: Insights, American Economic Association, vol. 5(4), pages 563-581, December.

    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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