Paper by Isabelle Salle and Cars Hommes published in the Journal of Monetary Economics
The paper 'Are long-horizon expectations (de-)stabilizing? Theory and experiments' by research fellows Isabelle Salle and Cars Hommes (University of Amsterdam), and co-authors Bruce McGough and George W. Evans (University of Oregon, United States) has been published online in the Journal of Monetary Economics.
Abstract
The impact of finite forecasting horizons on price dynamics is examined in a standard infinite-horizon asset-pricing model. Our theoretical results link forecasting horizon inversely to expectational feedback, and predict a positive relationship between expectational feedback and various measures of asset-price volatility. We design a laboratory experiment to test these predictions. Consistent with our theory, short-horizon markets are prone to substantial and prolonged deviations from rational expectations, whereas markets with even a modest share of long-horizon forecasters exhibit convergence. Longer-horizon forecasts display more heterogeneity but also prevent coordination on incorrect anchors – a pattern that leads to mispricing in short-horizon markets.
Article Citation
George W. Evans, Cars Hommes, Bruce McGough, and Isabelle Salle, “Are long-horizon expectations (de-)stabilizing? Theory and experiments", Journal of Monetary Economics, published online, doi.org/10.1016/j.jmoneco.2022.08.002.