Joshua Stillwagon, assistant professor of economics at Trinity College, has received a grant from the Institute for New Economic Thinking to continue his research on Imperfect Knowledge Economics. The $37,780 award will extend Stillwagon’s junior faculty leave to a full year.
According to Stillwagon, there is a prominent debate in the field of financial economics about whether financial markets are efficient or irrational. “My research looks at data of traders’ forecasts of future asset prices, to get a better idea of how they form their expectations,” Stillwagon said. This grant funds the continuation of that ongoing research.
“Most recently I’ve been looking at expectations of traders in the stock market to examine whether they focus on the fundamentals rational theory would imply, such as company earnings, or factors that the behavioral theories would suggest, such as extrapolation,” Stillwagon said. “The research is trying to weigh in on the debate of the rational theory versus behavioral theory. Both could be important, but they are often viewed as mutually exclusive. If you acknowledge there is change over time, then there is room for both of them to enter.”
The rational theory claims that all relevant information is incorporated in the appropriate way into asset prices, Stillwagon explained. The behavioral theory, however, argues that prices often deviate from appropriate values due to traders’ psychological biases. “This research project focuses on a deficiency common to these otherwise diametrically opposed schools of thought: they both presume that the forecasting strategies used by market participants, and therefore the relationship driving asset prices, are completely time invariant or at least changing in only a mechanical, predetermined manner,” Stillwagon said. “This work builds on that of Imperfect Knowledge Economics, which recognizes the pervasiveness of non-routine change and genuine uncertainty.”
This research examines how expectations are influenced by both behavioral and efficient market factors, but allows for structural change over time. “I’ve been working with survey data in other markets. Now we’re doing it in the stock market,” Stillwagon said. “Preliminary results for the stock market suggest that both are relevant for understanding traders’ expectations, but in evolving ways over time.”
Stillwagon is working on this project with Roman Frydman, professor of economics at New York University. “He has done a lot of work in the foreign exchange market, developing the Imperfect Knowledge Economics theory and looking at how the relationships change over time, and I have been doing empirical work with survey data primarily,” Stillwagon said. “Now we’re combining survey data and time-varying relationships for work on the stock market.” This work will be extended to both currency and bond markets.
Written by Andrew J. Concatelli