Noisy Memory and Over-Reaction to News
AbstractWe 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. 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.
CitationAzeredo da Silveira, Rava, and Michael Woodford. 2019. "Noisy Memory and Over-Reaction to News." AEA Papers and Proceedings, 109: 557-61. DOI: 10.1257/pandp.20191049
- D83 Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
- D84 Expectations; Speculations