Reflexivity, Expectations Feedback and almost Self-fulfilling Equilibria: Economic Theory, Empirical Evidence and Laboratory Experiments

Cars Hommes

No 13-206/II, Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: This discussion paper led to a publication in the 'Journal of Economic Methodology' , 20(4), 2013.

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 focussing on efficiency and welfare gains in correcting mispricing of almost self-fulfilling equilibria.

Keywords: Expectation feedback; self-fulfilling beliefs; heuristic switching model; experimental macroeconomics (search for similar items in EconPapers)
JEL-codes: C92 D83 D84 E32 (search for similar items in EconPapers)
Date: 2013-12-17
New Economics Papers: this item is included in nep-cbe, nep-exp and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (22)

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Related works:
Journal Article: 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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Persistent link: https://EconPapers.repec.org/RePEc:tin:wpaper:20130206

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