Noisy Memory and Over-Reaction to News / Rava Azeredo da Silveira, Michael Woodford.

Format:

Book

Author/Creator:

Azeredo da Silveira, Rava.

Contributor:

National Bureau of Economic Research.

Woodford, Michael.

Series:

Working Paper Series (National Bureau of Economic Research) no. w25478.

NBER working paper series no. w25478

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2019.

Summary:

We propose a model of optimal decision making subject to a memory constraint. The constraint is a limit on the complexity of memory measured using Shannon's mutual information, as in models of rational inattention; but our theory differs from that of Sims (2003) in not assuming costless memory of past cognitive states. We show that the model implies that both forecasts and actions will exhibit idiosyncratic random variation; that beliefs will fluctuate forever around the rational-expectations (perfect-memory) beliefs with a variance that does not fall to zero; and that more recent news will be given disproportionate weight. The model provides a simple explanation for a number of features of expectations in laboratory and field settings, most notably apparent over-reaction of both elicited forecasts and spending decisions to transitory fluctuations in economic time series.

Notes:

Print version record

January 2019.