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Individual Expectations, Limited Rationality and Aggregate Outcomes

Author

Listed:
  • Te Bao

    (University of Amsterdam)

  • Cars Hommes

    (University of Amsterdam)

  • Joep Sonnemans

    (University of Amsterdam)

  • Jan Tuinstra

    (University of Amsterdam)

Abstract

This discussion paper led to a publication in the Journal of Economic Dynamics & Control . Volume 36(8), pp. 1101-1120. 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 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.

Suggested Citation

  • Te Bao & Cars Hommes & Joep Sonnemans & Jan Tuinstra, 2012. "Individual Expectations, Limited Rationality and Aggregate Outcomes," Tinbergen Institute Discussion Papers 12-016/1, Tinbergen Institute.
    • Handle: RePEc:tin:wpaper:20120016
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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;
    All these keywords.

    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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