Reflexivity, expectations feedback and almost self-fulfilling equilibria: economic theory, empirical evidence and laboratory experiments

Cars Hommes

Journal of Economic Methodology, 2013, vol. 20, issue 4, 406-419

Abstract: We discuss recent work on bounded rationality and learning in relation to Soros' principle of reflexivity and stress the empirical importance of non-rational, almost self-fulfilling equilibria in positive feedback systems. As an empirical example, we discuss a behavioral asset pricing model with heterogeneous expectations. Bubble and crash dynamics is 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, almost self-fulfilling equilibria with persistent price fluctuations very different from rational equilibria. Economic policy analysis may benefit enormously by focusing on efficiency and welfare gains in correcting mispricing along almost self-fulfilling equilibria.

Date: 2013
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Citations: View citations in EconPapers (21)

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Working Paper: 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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DOI: 10.1080/1350178X.2013.859426

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