Why Diagnostic Expectations Cannot Replace REH

Roman Frydman () and Halina Frydman
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Roman Frydman: Department of Economics, New York University
Halina Frydman: Stern School of Business, New York University.

No inetwp175, Working Papers Series from Institute for New Economic Thinking

Abstract: Gennaioli and Shleifer (GS) have proposed diagnostic expectations (DE) as an empirically-based approach to specifying participants' expectations, which, like REH, can be applied in every model. Beyond its supposedly general applicability, GS's formalization of DE implies that participants systematically and predictably overreact to news. Here, we present a formal argument that Kahneman and Tversky's compelling empirical findings, and those of other behavioral economists, do not provide a basis for a general approach to specifying participants' "predictable errors." We also show that the overreaction of participants' expectations is not a regularity, but rather an artifact of GS's particular specification of DE.

Keywords: Rational Expectations Hypothesis; Diagnostic Expectations; Representativeness Heuristic. (search for similar items in EconPapers)
JEL-codes: D80 D84 E71 (search for similar items in EconPapers)
Pages: 22 pages
Date: 2022-01-18
New Economics Papers: this item is included in nep-mac and nep-ore
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Persistent link: https://EconPapers.repec.org/RePEc:thk:wpaper:inetwp175

DOI: 10.36687/inetwp175

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