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Narrative expectations in financial forecasting
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Johnson, Samuel G. B. and Tuckett, David (2022) Narrative expectations in financial forecasting. Journal of Behavioral Decision Making, 35 (1). e2245. doi:10.1002/bdm.2245 ISSN 0894-3257.
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Official URL: https://doi.org/10.1002/bdm.2245
Abstract
How do people form expectations about the future? We use amateur and expert investors’ expectations about financial asset prices to study this question. Three experiments contrast the rational expectations assumption from neoclassical economics (investors forecast according to neoclassical financial theory) against two psychological theories of expectation-formation—behaviorally-informed expectations (investors understand empirical market anomalies and expect these anomalies to occur) and narrative expectations (investors use narrative thinking to predict future prices). Whereas neoclassical financial theory maintains that past public information cannot be used to predict future prices, participants used company performance information revealed before a base price quotation to project future price trends after that quotation (Experiment 1), contradicting rational expectations. Importantly, these projections were stronger when information concerned predictions about a company’s future performance rather than actual data about its past performance, suggesting that people not only rely on financially irrelevant (but narratively relevant) information for making predictions, but erroneously impose temporal order on that information. These biased predictions had downstream consequences for asset allocation choices (Experiment 2) and these choices were driven in part by affective reactions to the company performance news (Experiment 3). There were some mild effects of expertise, but overall the effects of narrative appear to be consistent across all levels of expertise studied, including professional financial analysts. We conclude by discussing the prospects for a narrative theory of choice that provide new micro-foundational insights about economic behavior.
| Item Type: | Journal Article | |||||||||
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| Subjects: | B Philosophy. Psychology. Religion > BF Psychology H Social Sciences > HD Industries. Land use. Labor H Social Sciences > HG Finance |
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| Divisions: | Faculty of Science, Engineering and Medicine > Science > Psychology | |||||||||
| Library of Congress Subject Headings (LCSH): | Decision making -- Economic aspects, Decision making -- Psychological aspects, Investments -- Decision making, Expectation (Psychology) , Business enterprises -- Finance, Business forecasting, Corporations -- Finance -- Forecasting | |||||||||
| Journal or Publication Title: | Journal of Behavioral Decision Making | |||||||||
| Publisher: | John Wiley & Sons Ltd. | |||||||||
| ISSN: | 0894-3257 | |||||||||
| Official Date: | January 2022 | |||||||||
| Dates: |
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| Volume: | 35 | |||||||||
| Number: | 1 | |||||||||
| Article Number: | e2245 | |||||||||
| DOI: | 10.1002/bdm.2245 | |||||||||
| Status: | Peer Reviewed | |||||||||
| Publication Status: | Published | |||||||||
| Access rights to Published version: | Open Access (Creative Commons) | |||||||||
| Date of first compliant deposit: | 13 April 2021 | |||||||||
| Date of first compliant Open Access: | 13 April 2021 | |||||||||
| RIOXX Funder/Project Grant: |
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