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  4. October 2024
  5. Optimally Imprecise Memory and Biased Forecasts

American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

Optimally Imprecise Memory and Biased Forecasts

  • Rava Azeredo da Silveira
  • Yeji Sung
  • Michael Woodford
American Economic Review
vol. 114, no. 10, October 2024
(pp. 3075–3118)
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Abstract

We propose a model of optimal decision-making subject to a memory constraint in the spirit of models of rational inattention. Our theory differs from that of Sims (2003) in not assuming costless memory of past cognitive states. The model implies that both forecasts and actions will exhibit idiosyncratic random variation; that average beliefs will exhibit a bias that fluctuates forever; and that more recent news will be given disproportionate weight in forecasts. The model provides a simple explanation for the overreaction to news observed in the laboratory by Afrouzi et al. (2023).

Citation

Azeredo da Silveira, Rava, Yeji Sung, and Michael Woodford. 2024. "Optimally Imprecise Memory and Biased Forecasts." American Economic Review, 114 (10): 3075–3118. DOI: 10.1257/aer.20201806

Additional Materials

JEL Classification

  • D83 Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
  • D84 Expectations; Speculations
  • D91 Micro-Based Behavioral Economics: Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
  • G12 Asset Pricing; Trading Volume; Bond Interest Rates
  • G41 Behavioral Finance: Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets [Neurofinance]