Overreacting Beliefs in Finance and Economics

This thesis investigates overreacting beliefs in Finance and Economics. Chapter 1 investigates overreaction to news in the term structure of interest rates. We find evidence of overreaction whose intensity is increasing with maturity, causing excess volatility of long term interest rates. We incorporate non rational beliefs into an otherwise standard asset pricing model and we show that it captures excess volatility of asset prices as well as forecast errors predictability. The second Chapter investigates the consequences of over-reacting beliefs when agents interact, via the observation of past actions of others. Even though individually overreaction entails a loss (in the MSE sense), at the aggregate level it injects more private information into the economy, thereby increasing stability and avoiding informational cascades. The third Chapter investigates the foundations of overreaction to information in a constrained Bayesian updating framework. We show that a bound on the surprise an agent can experience from the data implies an overweight of current information and ultimately overreaction to information.