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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
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    Citations

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    Cited by:

    1. Link, Sebastian & Peichl, Andreas & Roth, Christopher & Wohlfart, Johannes, 2023. "Attention to the Macroeconomy," CEPR Discussion Papers 18699, C.E.P.R. Discussion Papers.
    2. Jonas Radbruch & Amelie Schiprowski, 2020. "Interview Sequences and the Formation of Subjective Assessments," ECONtribute Discussion Papers Series 045, University of Bonn and University of Cologne, Germany.
    3. Marianne Andries & Milo Bianchi & Karen Huynh & Sébastien Pouget, 2024. "Return Predictability, Expectations, and Investment: Experimental Evidence," Post-Print hal-04680777, HAL.
    4. Enke, Benjamin & Schwerter, Frederik & Zimmermann, Florian, 2024. "Associative memory, beliefs and market interactions," Journal of Financial Economics, Elsevier, vol. 157(C).
    5. Conrad, Christian & Lahiri, Kajal, 2023. "Heterogeneous expectations among professional forecasters," ZEW Discussion Papers 23-062, ZEW - Leibniz Centre for European Economic Research.
    6. Angelico, Cristina, 2024. "The green transition and firms' expectations on future prices: Survey evidence," Journal of Economic Behavior & Organization, Elsevier, vol. 221(C), pages 519-543.
    7. Charles, Constantin & Frydman, Cary & Kilic, Mete, 2024. "Insensitive investors," LSE Research Online Documents on Economics 120788, London School of Economics and Political Science, LSE Library.
    8. Yves Breitmoser & Justin Valasek & Justin Mattias Valasek, 2023. "Why Do Committees Work?," CESifo Working Paper Series 10800, CESifo.
    9. Matteo Bizzarri & Daniele d'Arienzo, 2023. "The social value of overreaction to information," CSEF Working Papers 690, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
    10. Leland Bybee, 2023. "Surveying Generative AI's Economic Expectations," Papers 2305.02823, arXiv.org, revised May 2023.
    11. Breitmoser, Yves & Valasek, Justin, 2023. "Why do committees work?," Discussion Paper Series in Economics 18/2023, Norwegian School of Economics, Department of Economics.

    More about this item

    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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