Francesca Bastianello

Working Papers

Partial Equilibrium Thinking, Extrapolation, and Bubbles
(with Paul Fontanier). Online Appendix. August 2024.
Review of Financial Studies, Revise and Resubmit. 

Abstract. We develop a dynamic theory of “Partial Equilibrium Thinking” (PET), which micro-founds time-varying price extrapolation: extrapolative beliefs are present at all times, but only sometimes manifest themselves in explosive ways. To study this systematically, we formalize the distinction between normal times shocks and “displacement shocks” (Kindleberger 1978). In normal times, PET generates constant extrapolation, contrarian trading, and price momentum. Instead, following a displacement shock that increases uncertainty, PET leads to stronger and time-varying extrapolation and momentum trading, triggering bubbles and endogenous crashes. Our theory sheds light on both normal times market dynamics and Kindleberger’s narrative of bubbles within a unified framework.

 

Expectations and Learning from Prices
(with Paul Fontanier). Online Appendix. January 2024.
Review of Economic Studies, Accepted.

Abstract. We study mislearning from equilibrium prices, and contrast this with mislearning from exogenous fundamentals. We micro-found mislearning from prices with a psychologically founded theory of “Partial Equilibrium Thinking” (PET), where traders learn fundamental information from prices, but fail to realize others do so too. PET leads to over-reaction, and upward sloping demand curves, thus contributing to more inelastic markets. The degree of individual-level over-reaction, and the extent of inelasticity varies with the composition of traders, and with the informativeness of new information. More generally, unlike mislearning from fundamentals, mislearning from prices i) generates a two-way feedback between prices and beliefs that can provide an arbitrarily large amount of amplification, and ii) can rationalize both over-reaction and more inelastic markets. The two classes of biases are not mutually exclusive. Instead, they interact in very natural ways, and mislearning from prices can vastly amplify mislearning from fundamentals.

 

Work in Progress

Underreaction and Overreaction in Inference and Forecasting
(with Alex Imas). 

Mental Models and Financial Forecasts
(with Paul Décaire and Marius Guenzel).

Expectations and Inelastic Markets

 

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