Stock-Market Expectations: Econometric Evidence that Both REH and Behavioral Insights Matter
36 Pages Posted: 11 Jun 2016
Date Written: May 19, 2016
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: Suggested Citation