Expectation Formation Following Large Unexpected Shocks

56 Pages Posted: 19 Mar 2018 Last revised: 16 Apr 2020

Date Written: March 19, 2018


By matching a large database of individual forecaster data with the universe of sizable natural disasters across 54 countries, we identify a set of new stylized facts: (i) forecasters are persistently heterogeneous in how often they issue or revise a forecast; (ii) information rigidity declines significantly following large, unexpected natural disaster shocks; (iii) the response of forecast disagreement displays interesting patterns: attentive forecasters tend to move away from the previous consensus following a disaster while the opposite is true for inattentive forecasters. We develop a learning model that captures the two channels through which natural disaster shocks affect expectation formation: attention effect { the visibly large shocks induce immediate and synchronized updating of information for inattentive agents, and uncertainty effect { the occurrence of those shocks generates increased uncertainty among attentive agents.

Keywords: Expectation Formation, Heterogeneous Agents, Information Rigidity, Learning, Natural Disasters, Uncertainty Shock

JEL Classification: C32, C53, D83, D84, E17, E37

Suggested Citation

Baker, Scott R. and McElroy, Tucker and Sheng, Xuguang Simon, Expectation Formation Following Large Unexpected Shocks (March 19, 2018). Review of Economics and Statistics, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3143894 or http://dx.doi.org/10.2139/ssrn.3143894

Scott R. Baker (Contact Author)

Northwestern University, Kellogg School of Management, Department of Finance ( email )

Evanston, IL 60208
United States

Tucker McElroy

U.S. Census Bureau - Center for Statistical Research and Methodology ( email )

4600 Silver Hill Road
Washington, DC 20233-9100
United States

Xuguang Simon Sheng

American University ( email )

4400 Massachusetts Avenue, N.W.
Washington, DC 20016-8029
United States

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