Journal of Economic Perspectives
ISSN 0895-3309 (Print) | ISSN 1944-7965 (Online)
Overreaction and Diagnostic Expectations in Macroeconomics
Journal of Economic Perspectives
vol. 36,
no. 3, Summer 2022
(pp. 223–44)
(Complimentary)
Abstract
We present the case for the centrality of overreaction in expectations for addressing important challenges in finance and macroeconomics. First, non-rational expectations by market participants can be measured and modeled in ways that address some of the key challenges posed by the rational expectations revolution, most importantly the idea that economic agents are forward-looking. Second, belief overreaction can account for many long-standing empirical puzzles in macro and finance, which emphasize the extreme volatility and boom-bust dynamics of key time series, such as stock prices, credit, and investment. Third, overreaction relies on psychology and is disciplined by survey data on expectations. This suggests that relaxing the assumption of rational expectations is a promising strategy, helps theory and evidence go together, and promises a unified view of a great deal of data.Citation
Bordalo, Pedro, Nicola Gennaioli, and Andrei Shleifer. 2022. "Overreaction and Diagnostic Expectations in Macroeconomics." Journal of Economic Perspectives, 36 (3): 223–44. DOI: 10.1257/jep.36.3.223Additional Materials
JEL Classification
- D83 Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
- D84 Expectations; Speculations
- E13 General Aggregative Models: Neoclassical
- E32 Business Fluctuations; Cycles
- E44 Financial Markets and the Macroeconomy
- G14 Information and Market Efficiency; Event Studies; Insider Trading
- G31 Capital Budgeting; Fixed Investment and Inventory Studies; Capacity
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