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Stock-Market Expectations: Econometric Evidence that both REH and Behavioral Insights Matter

Roman Frydman () and Josh Stillwagon ()
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Roman Frydman: New York University

No 44, Working Papers Series from Institute for New Economic Thinking

Abstract: Behavioral finance views stock-market investors’ expectations as largely unrelated to fundamental factors. Relying on survey data, this paper presents econometric evidence that fundamentals are a major driver of investors’ expectations. Although expectations are also in part extrapolative, this effect is transient. The paper’s approach underscores the central importance of opening models to structural change and imposing discipline on econometric analysis through specification testing. Our findings support the novel hypothesis that rational market participants, faced with unforeseeable change, base their forecasts on both fundamentals - the focus of the REH approach - and the psychological and technical considerations underlying behavioral finance.

Keywords: Behavioral finance; REH; Knightian uncertainty; survey expectations; structural change; model specification; automated model selection. (search for similar items in EconPapers)
JEL-codes: G12 G14 G02 C22 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fmk and nep-net
Date: 2016-05
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