Rational expectations models make stringent assumptions on the agent’s knowledge about the true model. This paper introduces a model in which the rational agent realizes that using a given model involves approximation errors, and adjusts behavior accordingly. If the researcher accounts for this empirical rationality on part of the agent, the resulting empirical model assigns likelihood to the d...

Why do large positive earnings surprises occur? The literature often treats large earnings surprises as the exogenous event that precipitates subsequent stock price drift, but analyst expectations and earnings realizations are the result of conscious decisions made by analysts and managers. While neither analysts nor managers have an obvious incentive for an extreme deviation between expected a...

We present a decision theoretic framework in which agents are learning about market behavior and that provides microfoundations for models of adaptive learning. Agents are ‘internally rational’, i.e., maximize discounted expected utility under uncertainty given consistent subjective beliefs about the future, but agents may not be ‘externally rational’, i.e., may not know the true stochastic pro...

The stock market is forward looking; economic indicators and important future events are factored into stock prices. According to the Efficient Market Hypothesis†, markets operate efficiently and stock prices instantly and stock prices instantly reflect all information available. However, inefficiencies in the stock market exist due to the behaviors and expectations of investors. Stock prices m...

Estimates of the historical equity risk premium in the UK are in the range 7% to 9% per annum. Until recently, portfolio investors and industrialists have been encouraged to use a premium of this order in making investment decisions. The purpose of this paper is to review the risk premium debate and to re-inforce the case for rejecting historical experience in formulating future investment plan...

In this paper, we design an automated system that predicts the impact of central bank communications on investors’ interest rate expectations. Our corpus is the Bank of England’s ‘Monetary Policy Committee Minutes'. Prior studies suggest that effective communications can mitigate a financial crisis; ineffective communications may exacerbate one. The system described here works in four phases. F...

Accommodating asymmetric information in a dynamic asset pricing model is technically challenging due to the problems associated with higher-order expectations. That is, rational investors are forced into a situation where they must forecast the forecasts of other agents. In a dynamic setting, this problem telescopes into the infinite future and the dimension of the relevant state space approach...

Keynes (1936) was right to emphasize that the investors' expectations have a paramount effect on the evolution of the national economy. Indeed, an impor­ tant part of the role of the financial services sector in a modern economy is to try to forecast how the central bank will react to macroeconomic shocks, and any Wall Street economist worth his or her salt has a rule of thumb-a model drawn per...

We propose a theory of asset pricing based on heterogeneous agents who continually adapt their expectations to the market that these expectations aggregatively create. And we explore the implications of this theory computationally using our Santa Fe artificial stock market. Asset markets, we argue, have a recursive nature in that agents’ expectations are formed on the basis of their anticipatio...

This study examines how managers’ use of expectation management is affected by labor market mobility, measured with the enforceability of non-compete provisions in employment contracts. We find that managers in states with stricter non-compete enforcement are more likely to manage analyst expectations downward, consistent with labor market immobility exacerbating managers’ incentives to ensure ...