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Individual Expectations, Limited Rationality and Aggregate Outcomes

Te Bao, Cars Hommes (), Joep Sonnemans () and Jan Tuinstra ()

No 12-016/1, Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: This discussion paper led to a publication in the Journal of Economic Dynamics & Control . Volume 36(8), pp. 1101-1120. Recent studies suggest that the type of strategic environment or expectation feedback can have a large impact on whether the market can learn the rational fundamental price. We present an experiment where the fundamental price experiences large unexpected shocks. Markets with negative expectation feedback (strategic substitutes) quickly converge to the new fundamental, while markets with positive expectation feedback (strategic complements) do not converge, but show under-reaction in the short run and over-reaction in the long run. A simple evolutionary selection model of individual learning explains these differences in aggregate outcomes.

Keywords: Expectation feedback; under- and overreaction; strategic substitutes and strategic complements; heuristic switching model; experimental economics (search for similar items in EconPapers)
JEL-codes: C92 G14 D84 D83 E37 (search for similar items in EconPapers)
Date: 2012-02-17
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Related works:
Journal Article: Individual expectations, limited rationality and aggregate outcomes (2012) Downloads
Working Paper: Individual Expectations, Limited Rationality and Aggregate Outcomes (2010) Downloads
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