Abstract

http://ssrn.com/abstract=412801
 
 

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Simple Forecasts and Paradigm Shifts


Harrison G. Hong


Princeton University - Department of Economics; National Bureau of Economic Research (NBER)

Jeremy C. Stein


Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

May 2003

Harvard Institute of Economic Research Discussion Paper No. 2007; AFA 2005 Philadelphia Meetings

Abstract:     
We postulate that agents make forecasts using overly simplified models of the world - i.e., models that only embody a subset of available information. We then go on to study the implications of learning in this environment. Our key premise is that learning is based on a model-selection criterion. Thus if a particular simple model does a poor job of forecasting over a period of time, it is eventually discarded in favor of an alternative, yet equally simple model that would have done better over the same period. This theory makes several distinctive predictions, which, for concreteness, we develop in a stock-market setting. For example, starting with symmetric and homoskedastic fundamentals, the theory yields forecastable variation in the size of the value/glamour differential, in volatility, and in the skewness of returns. Some of these features mirror familiar accounts of stock-price bubbles.

Number of Pages in PDF File: 49

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Date posted: February 13, 2005  

Suggested Citation

Hong, Harrison G. and Stein, Jeremy C., Simple Forecasts and Paradigm Shifts (May 2003). Harvard Institute of Economic Research Discussion Paper No. 2007; AFA 2005 Philadelphia Meetings. Available at SSRN: http://ssrn.com/abstract=412801 or http://dx.doi.org/10.2139/ssrn.412801

Contact Information

Harrison G. Hong
Princeton University - Department of Economics ( email )
Princeton, NJ 08544-1021
United States
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Jeremy C. Stein (Contact Author)
Harvard University - Department of Economics ( email )
Littauer Center
Cambridge, MA 02138
United States
617-496-6455 (Phone)
617-496-7352 (Fax)
HOME PAGE: http://post.economics.harvard.edu/faculty/stein/stein.html
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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