Seminarium: Francesco Bianchi, John Hopkins

Abstract: " We show that the formalization of representativeness (Kahneman and Tversky (1972)) developed by Gennaioli and Shleifer (2010) features an intrinsic connection between uncertainty and overreaction. In the time series domain, we develop this connection in a smooth version of Diagnostic Expectations (DE). Intuitively, under smoothness, when uncertainty is low there is less room for representativeness to distort beliefs. Smooth DE implies a joint and parsimonious micro-foundation for key properties of survey data: overreaction to news, stronger overreaction for longer forecast horizons, overconfidence in subjective uncertainty, and a new stylized fact documented in this paper, namely that overreaction is stronger when uncertainty is high. An analytical Real Business Cycle model featuring Smooth DE accounts for overreaction and overconfidence in surveys, as well as three salient properties of the business cycle: asymmetry, countercyclical micro volatility, and countercyclical macro volatility."