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Are long-horizon expectations (de-)stabilizing? Theory and experiments

George Evans (), Cars Hommes (), Bruce McGough and Isabelle Salle

Journal of Monetary Economics, 2022, vol. 132, issue C, 44-63

Abstract: The impact of finite forecasting horizons on price dynamics is examined in a standard infinite-horizon asset-pricing model. Our theoretical results link forecasting horizon inversely to expectational feedback, and predict a positive relationship between expectational feedback and various measures of asset-price volatility. We design a laboratory experiment to test these predictions. Consistent with our theory, short-horizon markets are prone to substantial and prolonged deviations from rational expectations, whereas markets with even a modest share of long-horizon forecasters exhibit convergence. Longer-horizon forecasts display more heterogeneity but also prevent coordination on incorrect anchors – a pattern that leads to mispricing in short-horizon markets.

Keywords: Learning; Long-horizon expectations; Asset pricing; Experiments (search for similar items in EconPapers)
JEL-codes: C92 D84 E70 (search for similar items in EconPapers)
Date: 2022
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Working Paper: Are Long-Horizon Expectations (De-)Stabilizing? Theory and Experiments (2019) Downloads
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DOI: 10.1016/j.jmoneco.2022.08.002

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