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Why Diagnostic Expectations Cannot Replace REH

Author

Listed:
  • Roman Frydman

    (Department of Economics, New York University)

  • Halina Frydman

    (Stern School of Business, New York University.)

Abstract

Gennaioli and Shleifer (GS) have proposed diagnostic expectations (DE) as an empirically-based approach to specifying participants' expectations, which, like REH, can be applied in every model. Beyond its supposedly general applicability, GS's formalization of DE implies that participants systematically and predictably overreact to news. Here, we present a formal argument that Kahneman and Tversky's compelling empirical findings, and those of other behavioral economists, do not provide a basis for a general approach to specifying participants' "predictable errors." We also show that the overreaction of participants' expectations is not a regularity, but rather an artifact of GS's particular specification of DE.

Suggested Citation

  • Roman Frydman & Halina Frydman, 2022. "Why Diagnostic Expectations Cannot Replace REH," Working Papers Series inetwp175, Institute for New Economic Thinking.
    • Handle: RePEc:thk:wpaper:inetwp175
    DOI: 10.36687/inetwp175
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    References listed on IDEAS

    as
    1. Barberis, Nicholas & Thaler, Richard, 2003. "A survey of behavioral finance," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 18, pages 1053-1128, Elsevier.
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    Keywords

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    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E71 - Macroeconomics and Monetary Economics - - Macro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on the Macro Economy

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