Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/89251
Authors: 
Hommes, Cars
Year of Publication: 
2013
Series/Report no.: 
Tinbergen Institute Discussion Paper 13-206/II
Abstract: 
We discuss recent work on bounded rationality and learning in relation to Soros' principle of reflexivity and stress the empirical importance of non-rational, almost self-fulfilling equilibria in positive feedback systems. As an empirical example, we discuss a behavioral asset pricing model with heterogeneous expectations. Bubble and crash dynamics is triggered by shocks to fundamentals and amplified by agents switching endogenously between a mean-reverting fundamental rule and a trend-following rule, based upon their relative performance. We also discuss learning-to-forecast laboratory experiments, showing that in positive feedback systems individuals coordinate expectations on non-rational, almost self-fulfilling equilibria with persistent price fluctuations very different from rational equilibria. Economic policy analysis may benefit enormously by focussing on efficiency and welfare gains in correcting mispricing of almost self-fulfilling equilibria.
Subjects: 
Expectation feedback
self-fulfilling beliefs
heuristic switching model
experimental macroeconomics
JEL: 
D84
D83
E32
C92
Document Type: 
Working Paper

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