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Individual expectations, limited rationality and aggregate outcomes

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Listed:
  • Bao, Te
  • Hommes, Cars
  • Sonnemans, Joep
  • Tuinstra, Jan

Abstract

Recent studies suggest that the type of strategic environment or expectation feedback can have a large impact on whether the market can learn the rational fundamental price. We present an experiment where the fundamental price experiences large unexpected shocks. Markets with negative expectation feedback (strategic substitutes) quickly converge to the new fundamental, while markets with positive expectation feedback (strategic complements) do not converge, but show underreaction in the short run and overreaction in the long run. A simple evolutionary selection model of individual learning explains these differences in aggregate outcomes.

Suggested Citation

  • Bao, Te & Hommes, Cars & Sonnemans, Joep & Tuinstra, Jan, 2012. "Individual expectations, limited rationality and aggregate outcomes," Journal of Economic Dynamics and Control, Elsevier, vol. 36(8), pages 1101-1120.
  • Handle: RePEc:eee:dyncon:v:36:y:2012:i:8:p:1101-1120
    DOI: 10.1016/j.jedc.2012.03.006
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    References listed on IDEAS

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    More about this item

    Keywords

    Expectation feedback; Under and overreaction; Strategic substitutes and strategic complements; Heuristic switching model; Experimental economics;

    JEL classification:

    • C92 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Group Behavior
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications

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