Are long-horizon expectations (de-)stabilizing? Theory and experiments

Arbeitspapier

We consider boundedly rational agents who do not plan over the infinite future but make trading plans at a finite, arbitrary horizon. We investigate the role of that horizon in the price dynamics of an asset in a Lucas tree model. We then design a laboratory experiment to test our theoretical predictions against the behaviors of human subjects. Short-horizon markets are prone to substantial and prolonged deviations from rational expectations (RE). By contrast, markets populated by even a modest share of long-horizon forecasters exhibit convergence towards the fundamental price. Longer-horizon forecasts do display more heterogeneity and thus some departure from RE; however this same heterogeneity also prevents the coordination of subjects on wrong anchors - a pattern of behavior that leads to mispricing in short-horizon markets. Long-horizon forecasts are well-described by adaptive learning, which delivers convergence to RE equilibrium, while short-horizon forecasts exhibit destabilizing trend-chasing.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Bank of Canada Staff Working Paper ; No. 2019-27

Classification and Topics

• Classification: Wirtschaft ; Design of Experiments: Laboratory, Group Behavior ; Expectations; Speculations ; Macro-Based Behavioral Economics: General‡
• Subject: Asset pricing ; Central bank research ; Economic models and financial markets

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Evans, George W. ; Hommes, Cars H. ; McGough, Bruce ; Salle, Isabelle
• Event: Veröffentlichung
• (who): Bank of Canada
• (where): Ottawa
• (when): 2019

Further information

• DOI: doi:10.34989/swp-2019-27
• Handle: http://hdl.handle.net/10419/210767
• Last update: 10.03.2025, 11:43 AM CET