Overreaction in Expectations: Evidence and Theory

76 Pages Posted: 18 Nov 2021

See all articles by Hassan Afrouzi

Hassan Afrouzi

Columbia University

Spencer Yongwook Kwon

Harvard University

Augustin Landier

HEC

Yueran Ma

University of Chicago - Booth School of Business

David Thesmar

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Date Written: October 11, 2020

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.

Keywords: expectations, experiment, overreaction

JEL Classification: C91,D8

Suggested Citation

Afrouzi, Hassan and Kwon, Spencer Yongwook and Landier, Augustin and Ma, Yueran and Thesmar, David, Overreaction in Expectations: Evidence and Theory (October 11, 2020). Available at SSRN: https://ssrn.com/abstract=3709548 or http://dx.doi.org/10.2139/ssrn.3709548

Hassan Afrouzi

Columbia University ( email )

3022 Broadway
New York, NY 10027
United States

Spencer Yongwook Kwon

Harvard University

1875 Cambridge Street
Cambridge, MA 02138
United States

Augustin Landier

HEC ( email )

France
+33630006051 (Phone)

HOME PAGE: http://https://sites.google.com/site/augustinlandier/

Yueran Ma

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

David Thesmar (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
Cambridge, MA 02142
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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