Rethinking the Role of the Representativeness Heuristic in Macroeconomics and Finance Theory

Roman Frydman () and Morten Nyboe Tabor
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Roman Frydman: Department of Economics, New York University
Morten Nyboe Tabor: Institute for New Economic Thinking (INET)

No inetwp142, Working Papers Series from Institute for New Economic Thinking

Abstract: We propose a novel interpretation and formalization of Kahneman and Tversky's findings in the Linda experiment which implies that subjects are rational in the sense of Muth's hypothesis and provides an approach to specifying rational assessment of uncertainty in macroeconomic models. Behavioral-finance theorists have appealed to Kahneman and Tversky's findings as an empirical foundation for a general approach replacing rational expectations. We show that behavioral models' specifications of participants' irrational forecasts and predictable errors are incompatible with Kahneman and Tversky's findings. Our interpretation of Kahneman and Tversky's findings is supportive of Lucas's compelling critique of inconsistent macroeconomic models.

Keywords: Uncertainty in Economic Models; Kahneman and Tversky's Experimental Findings; Behavioral Finance; Muth's Hypothesis; REH. (search for similar items in EconPapers)
JEL-codes: B41 D80 D81 D91 E71 G41 (search for similar items in EconPapers)
Pages: 42 pages
Date: 2020-12-14
New Economics Papers: this item is included in nep-cbe, nep-exp, nep-hpe, nep-mac, nep-ore, nep-pke and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:thk:wpaper:inetwp142

DOI: 10.36687/inetwp142

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