Publication | Closed Access
On the nature of expectations
73
Citations
0
References
1994
Year
Forecasting MethodologyEngineeringBehavioral Decision MakingAdaptive ModelIndividual Decision MakingTime Series EconometricsEconomic ForecastingExperimental EconomicsEconomic AnalysisCognitive Bias MitigationDecision TheoryStatisticsExpectation FormationEconomicsBehavioral SciencesForecastingBehavioral EconomicsBusinessEconometricsRational ModelFinancial Forecast
We review economic and psychological models of expectation formation. According to the rational model, expectations are optimal; according to the adaptive model, they minimize previous error; according to the extrapolative model, they continue a trend. In an experiment, we asked subjects to make forecasts from previous data in the same series or from previous data in a different but related series. We also asked them to estimate the probability that their forecasts would be correct. The rational model failed because within‐series forecasts were too poor, cross‐series forecasts were biased, and probability estimates showed overconfidence. Regression analyses and a lack of performance improvement showed that the adaptive model was inappropriate. Instead, within‐series forecasts were made by extrapolation and cross‐series forecasts appeared to be based on a faulty conditional rule.