Reflexivity, Expectations Feedback and Almost Self-fulfilling Equilibria: Economic Theory, Empirical Evidence and Laboratory Experiments

Cars Hommes

No 13-19, CeNDEF Working Papers from Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance

Abstract: We discuss recent work on bounded rationality and learning in relation to Soros' principles of reflexivity and stress the empirical relevance of non-rational, almost self-fulfilling equilibria in positive feedback systems. We fit a behavioral asset pricing model with heterogeneous expectations to the S&P 500 stock market index. Bubble and crash dynamics are triggered by shocks to fundamentals and amplified by agents switching endogenously between a mean-reverting fundamental rule and a trend-following rule, based upon their relative performance. We also discuss learning-to-forecast laboratory experiments, showing that in positive feedback systems individuals coordinate expectations on non-rational, trend-following rules and almost self-fulfilling equilibria with persistent price fluctuations very different from rational equilibria. Economic policy analysis may be much more effective by focussing on efficiency and welfare gains in correcting mispricing along almost self-fulfilling equilibria.

Date: 2013
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Citations: View citations in EconPapers (27)

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Related works:
Journal Article: Reflexivity, expectations feedback and almost self-fulfilling equilibria: economic theory, empirical evidence and laboratory experiments (2013)
Working Paper: Reflexivity, Expectations Feedback and almost Self-fulfilling Equilibria: Economic Theory, Empirical Evidence and Laboratory Experiments (2013)
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