The Inference-Forecast Gap in Belief Updating

Abstract

Evidence from experiments, surveys, and the field has uncovered both underreaction and overreaction to new information. We provide new experimental evidence on the underlying mechanisms of under- and overreaction by comparing how people make inferences and revise fore- casts in the same information environment. Participants underreact to signals when inferring about underlying states, but overreact to the same signals when revising forecasts about future outcomes—a phenomenon we term “the inference-forecast gap.” We show that this gap is largely driven by different simplifying heuristics used in the two tasks. Additional treatments suggest that the choice of heuristics is affected by the similarity between statistics in the information environment and the statistic elicited by the belief-updating problem.

Keywords: belief updating, updating biases, inference problems, forecast revision, extrapolation, heuristics, similarity

JEL Classification: C91, D83, D90, D91