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Individual Expectations, Limited Rationality and Aggregate Outcomes

  • Bao, T.

    ()

    (University van Amsterdam)

  • Hommes, C.H.

    ()

    (University of Amsterdam)

  • Sonnemans, J.

    (University van Amsterdam)

  • Tuinstra, J.

    ()

    (University van Amsterdam)

Recent studies suggest that the type of strategic environment or expectation feedback may have a large impact on whether the market learns 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 under-reaction in the short run and over-reaction in the long run. A simple evolutionary selection model of individual learning explains these differences in aggregate outcomes.

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File URL: http://www1.fee.uva.nl/cendef/publications/papers/BHST2010_June.pdf
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Paper provided by Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance in its series CeNDEF Working Papers with number 10-07.

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Date of creation: 2010
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Handle: RePEc:ams:ndfwpp:10-07
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