Research Interest
Heterogeneous Households, Expectation Formation, Wealth Inequality, Macro-Public Finance
Working papers
“Belief Heterogeneity and Heuristics as Drivers of Wealth Inequality ” JMP
Using microdata, we document heterogeneity in overreaction in household-finance expectations. Low-income households overreact more strongly to recent household-finance experience when forming expectations about future finances, while high-income households look closer to a no-overreaction benchmark. Motivated by this evidence, we incorporate heterogeneity in overreaction into an incomplete markets with both idiosyncratic and aggregate risks. The calibrated model implies a negative relationship between the extent of overreaction and wealth. Overreacting households become too pessimistic after bad experiences triggered by recession and too optimistic after good experiences triggered by expansion, which shifts saving incentives in a state-dependent way. Because our business cycle calibration features persistent expansions and rare severe recessions, optimistic under-saving episodes dominate on average and overreactors accumulate less wealth. The wealth-overreaction relationship weakens in recessions, when fewer households are in good states. In a policy experiment, a flat wealth tax reduces wealth concentration in both the benchmark and a rational version of the model. However, the reduction is larger under overreaction because the policy affects beliefs through its impact on household finances and partly corrects optimistic beliefs.
“Herding and Contrarianism under Diagnostic Expectations”
This paper studies informational herding and contrarian behaviour in a sequential trading model. In the canonical rational expectations model, informed traders continue to act on their private signals, and price adjustment is powerful enough to rule out herding and contrarian behaviour. I show that this conclusion relies on the Bayesian use of public information summarized in prices. When some informed traders form diagnostic expectations, they overweight the asset state that recent public information has made more representative relative to an earlier public history. This overreaction can make public news dominate private information. Diagnostic informed traders may then disregard their private signal and trade with or against the direction favoured by current public beliefs. The mechanism survives even when prices respond to order flow and the market maker accounts for diagnostic traders in pricing. The paper identifies a belief-based channel through which price histories can generate herding and contrarian behaviour in sequential trade.
Work in progress
"Redistribution without Rational Expectations”, with Patrick Macnamara and Raffaele Rossi
"Pareto Optimal Reforms”, with Patrick Macnamara and Raffaele Rossi