Noisy Memory and Over-Reaction to News

Rava Azeredo da Silveira and Michael Woodford

AEA Papers and Proceedings, 2019, vol. 109, 557-61

Abstract: We propose a model of optimal decision-making subject to a memory constraint. The constraint is a limit on the complexity of memory measured using Shannon's mutual information, as in models of rational inattention. We show that the model implies that both forecasts and actions will exhibit idiosyncratic random variation; that beliefs will fluctuate forever around the rational-expectations (perfect-memory) beliefs with a variance that does not fall to zero; and that more recent news will be given disproportionate weight. The model provides a simple explanation for a number of features of expectations in laboratory and field settings.

JEL-codes: D83 D84 (search for similar items in EconPapers)
Date: 2019
Note: DOI: 10.1257/pandp.20191049
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Citations: View citations in EconPapers (16)

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Related works:
Working Paper: Noisy Memory and Over-Reaction to News (2019)
Working Paper: Noisy Memory and Over-Reaction to News (2019)
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