Morning Must-Read: Noah Smith Reads Andrei Shleifer, Jeremy Greenwood, and Company on Trend-Chasing
Noah Smith: Does trend-chasing explain financial markets?: "Why do stock prices mean-revert in the long run?...
...Some people say that it's because of time-varying risk premia with Rational Expectations; others say that it's because of people's incorrect information processing, and expectations are non-rational.... Andrei Shleifer and Robin Greenwood... take an extremely simple approach toward measuring people expectations: Just ask people what they think is going to happen!... Survey [expectations] measures are... strongly correlated... consistent with investors' actions.... What causes people to expect higher stock returns?... Trend-chasing... seems to fit the facts very well.... Extrapolative Expectations beat Rational Expectations. That result would imply that trend-chasing by quasi-rational investors is the big force behind long-term stock return predictability.... But... [this] leaves the turning points unexplained.... There must be a role for hetergeneous investor expectations.... The refinement that Greenwood and Shleifer make in this 2013 paper, in which they team up with Nicholas Barberis and Lawrence Jin. They make a theoretical model where some investors are extrapolative trend-chasers and some are rational...
