Fundamental factors and extrapolation in stock-market expectations: The central role of structural change

Roman Frydman, Joshua R. Stillwagon

    Research output: Contribution to journalArticle

    Abstract

    Rational expectations and behavioral-finance models are widely interpreted as representing two distinct conceptions of decision-making: rational and irrational, respectively. Using survey data, this paper presents econometric evidence that both fundamental factors and extrapolation drive participants’ expectations of stock returns, but that they do so in ways that vary over time. Although both the REH and behavioral-finance approaches offer relevant insights for understanding participants’ expectations, neither of these distinct model classes is consistent with time-series data. The paper's findings also suggest that structural change gives rise to ambiguity about the correct quantitative model driving outcomes. This ambiguity, faced by economists and market participants alike, is the key to according both fundamental and behavioral factors a role in rational forecasting.

    Original languageEnglish (US)
    Pages (from-to)189-198
    Number of pages10
    JournalJournal of Economic Behavior and Organization
    Volume148
    DOIs
    StatePublished - Apr 2018

    Keywords

    • Asset-market expectations
    • Automatic model selection
    • Behavioral finance
    • Model ambiguity
    • REH
    • Structural change

    ASJC Scopus subject areas

    • Economics and Econometrics
    • Organizational Behavior and Human Resource Management

    Fingerprint Dive into the research topics of 'Fundamental factors and extrapolation in stock-market expectations: The central role of structural change'. Together they form a unique fingerprint.

  • Cite this