Stock-Market Expectations: Econometric Evidence that Both REH and Behavioral Insights Matter

36 Pages Posted: 11 Jun 2016

See all articles by Roman Frydman

Roman Frydman

New York University (NYU) - Department of Economics

Joshua Stillwagon

Trinity College (Hartford CT)

Date Written: May 19, 2016

Abstract

Behavioral finance views stock-market investors’ expectations as largely unrelated to fundamental factors. Relying on survey data, this paper presents econometric evidence that fundamentals are a major driver of investors’ expectations. Although expectations are also in part extrapolative, this effect is transient. The paper’s approach underscores the central importance of opening models to structural change and imposing discipline on econometric analysis through specification testing. Our findings support the novel hypothesis that rational market participants, faced with unforeseeable change, base their forecasts on both fundamentals - the focus of the REH approach - and the psychological and technical considerations underlying behavioral finance.

Keywords: Behavioral finance, REH, Knightian uncertainty, survey expectations, structural change, model specification, automated model selection

JEL Classification: G12, G14, G02, C22

Suggested Citation

Frydman, Roman and Stillwagon, Joshua, Stock-Market Expectations: Econometric Evidence that Both REH and Behavioral Insights Matter (May 19, 2016). Institute for New Economic Thinking Working Paper Series No. 44. Available at SSRN: https://ssrn.com/abstract=2793421 or http://dx.doi.org/10.2139/ssrn.2793421

Roman Frydman (Contact Author)

New York University (NYU) - Department of Economics ( email )

19 West 4th Street
New York, NY 10012
United States

Joshua Stillwagon

Trinity College (Hartford CT) ( email )

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