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Individual Expectations, Limited Rationality and Aggregate Outcomes

Journal of Economic Dynamics and Control, Vol. 36, No. 8, 2012

Tinbergen Institute Discussion Paper No. 12-016/1

45 Pages Posted: 18 Feb 2012 Last revised: 8 Oct 2012

Te Bao

Nanyang Technological University (NTU) - Division of Economics; University of Amsterdam - CeNDEF

Cars H. Hommes

University of Amsterdam - Amsterdam School of Economics (ASE); CeNDEF; Tinbergen Institute

Joep Sonnemans

University of Amsterdam - Amsterdam School of Economics (ASE)

Jan Tuinstra

University of Amsterdam - Department of Quantitative Economics (KE); Tinbergen Institute

Multiple version iconThere are 2 versions of this paper

Date Written: February 16, 2012

Abstract

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 over-reaction, strategic substitutes and strategic complements, heuristic switching model, experimental economics

JEL Classification: C92, G14, D84, D83, E37

Suggested Citation

Bao, Te and Hommes, Cars H. and Sonnemans, Joep and Tuinstra, Jan, Individual Expectations, Limited Rationality and Aggregate Outcomes (February 16, 2012). Journal of Economic Dynamics and Control, Vol. 36, No. 8, 2012; Tinbergen Institute Discussion Paper No. 12-016/1. Available at SSRN: https://ssrn.com/abstract=2007137 or http://dx.doi.org/10.2139/ssrn.2007137

Te Bao (Contact Author)

Nanyang Technological University (NTU) - Division of Economics ( email )

HSS 04-53, 14 Nanyang Drive
Singapore, 639798
Singapore

University of Amsterdam - CeNDEF ( email )

Roetersstraat 11
Amsterdam, NL-1018WB
Netherlands

Cars H. Hommes

University of Amsterdam - Amsterdam School of Economics (ASE) ( email )

Center for Nonlinear Dynamics in Economics and Finance
1018 WB Amsterdam
Netherlands
+31 20 525 4246 (Phone)
+31 20 525 4349 (Fax)

CeNDEF ( email )

Roetersstraat 11
Amsterdam, NL-1018WB
Netherlands

HOME PAGE: http://www1.fee.uva.nl/cendef/

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Joep Sonnemans

University of Amsterdam - Amsterdam School of Economics (ASE) ( email )

Roetersstraat 11
1018 WB Amsterdam
Netherlands
+31 20 525 4249 (Phone)
+31 20 525 5283 (Fax)

Jan Tuinstra

University of Amsterdam - Department of Quantitative Economics (KE) ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

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