The Inference-Forecast Gap in Belief Updating

Publication Date
Financial Markets Group Discussion Papers DP 908
Publication Authors

Evidence from experiments, surveys, and the field has uncovered both underreaction and overreaction to new information. We provide new experimental evidence on the underlying mechanisms of under- and overreaction by comparing how people make inferences and revise forecasts in the same information environment. Participants underreact to signals when inferring about underlying states, but overreact to the same signals when revising forecasts about future outcomes—a phenomenon we term “the inference-forecast gap.” We show that this gap is largely driven by different simplifying heuristics used in the two tasks, and we provide evidence supporting both similarity and timing as plausible mechanisms.