Expectation Formation with Correlated Variables

54 Pages Posted: 17 Sep 2019 Last revised: 22 May 2020

See all articles by Simin He

Simin He

Shanghai University of Finance and Economics - School of Economics

Simas Kucinskas

Humboldt University of Berlin

Date Written: May 22, 2020

Abstract

We experimentally study how people form expectations about correlated variables. Subjects forecast a time-series variable A. In the baseline treatment, subjects only observe past values of A. In the correlated treatment, they additionally observe an informative correlated variable B. Our novel experimental design ensures that A is equally predictable across treatments. Subjects are significantly less accurate in the correlated treatment, inconsistent with Bayesian learning. Subjects react to news asymmetrically, overreacting to A but underreacting to B, and they exhibit overall underreaction in the correlated treatment. Our findings may partially explain why under- and overreaction coexist in the field.

Keywords: Complexity, overreaction, underreaction, expectation formation

JEL Classification: C53, C93, D83, D84

Suggested Citation

He, Simin and Kucinskas, Simas, Expectation Formation with Correlated Variables (May 22, 2020). Available at SSRN: https://ssrn.com/abstract=3450207 or http://dx.doi.org/10.2139/ssrn.3450207

Simin He

Shanghai University of Finance and Economics - School of Economics ( email )

777 Guoding Road
Shanghai, 200433
China

Simas Kucinskas (Contact Author)

Humboldt University of Berlin

Dorotheenstrasse 1
Berlin, Berlin 10099
Germany

HOME PAGE: http://www.simaskucinskas.com

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