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Overreaction in Expectations: Evidence and Theory

Author

Listed:
  • Hassan Afrouzi

    (Columbia University [New York])

  • Spencer Yongwook Kwon

    (Harvard University)

  • Augustin Landier

    (HEC Paris - Ecole des Hautes Etudes Commerciales)

  • Yueran Ma

    (Booth School of Business [Chicago] - University of Chicago)

  • David Thesmar

    (MIT - Massachusetts Institute of Technology)

Abstract

We investigate biases in expectations across different settings through a large-scale randomized experiment where participants forecast stable stochastic processes. The experiment allows us to control forecasters' information sets as well as the data generating process, so we can cleanly measure biases in beliefs. We find that forecasts display significant overreaction to the most recent observation. Moreover, overreaction is especially pronounced for less persistent processes and longer forecast horizons. We also find that commonly-used expectations models do not easily account for these variations in the degree of overreaction across different settings. To explain the observed patterns of overreaction, we develop a tractable model of expectations formation with costly information processing. Our model closely fits the empirical findings and generates additional predictions that we confirm in the data.

Suggested Citation

  • Hassan Afrouzi & Spencer Yongwook Kwon & Augustin Landier & Yueran Ma & David Thesmar, 2020. "Overreaction in Expectations: Evidence and Theory," Working Papers hal-03885149, HAL.
    • Handle: RePEc:hal:wpaper:hal-03885149
    DOI: 10.2139/ssrn.3709548
    as

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    Keywords

    expectations; experiment; overreaction;
    All these keywords.

    JEL classification:

    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General

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