The Inference-Forecast Gap in Belief Updating

62 Pages Posted: 20 Jul 2021 Last revised: 22 Apr 2022

See all articles by Tony Fan

Tony Fan

Stanford University

Yucheng Liang

Carnegie Mellon University - David A. Tepper School of Business

Cameron Peng

London School of Economics & Political Science (LSE) - Department of Finance

Date Written: July 18, 2021

Abstract

Individual forecasts of economic variables show widespread overreaction to recent news, but laboratory experiments on belief updating typically find underinference from new signals. We provide new experimental evidence to connect these two seemingly inconsistent phenomena. Building on a classic experimental paradigm, we study how people make inferences and revise forecasts in the same information environment. Participants underreact to signals when inferring about underlying states, but overreact to signals when revising forecasts about future outcomes. This gap in belief updating is largely driven by the use of different simplifying heuristics for the two tasks. Additional treatments suggest that the choice of heuristics is affected by the similarity between cues in the information environment and the belief-updating question: when forming a posterior belief, participants are more likely to rely on cues that appear similar to the variable elicited by the question.

Keywords: belief updating, forecast revision, heuristics

JEL Classification: D83, D90

Suggested Citation

Fan, Tony and Liang, Yucheng and Peng, Cameron, The Inference-Forecast Gap in Belief Updating (July 18, 2021). Available at SSRN: https://ssrn.com/abstract=3889069 or http://dx.doi.org/10.2139/ssrn.3889069

Tony Fan

Stanford University ( email )

Stanford, CA 94305
United States

Yucheng Liang (Contact Author)

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States

HOME PAGE: http://yuchengliang.com

Cameron Peng

London School of Economics & Political Science (LSE) - Department of Finance ( email )

United Kingdom

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