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When people hear something new about a topic, they should update their beliefs to reflect the new information. But many people either underreact or overreact, with their responses varying based on different factors, including the environment. In 鈥�,鈥� researchers compared how people make inferences and revise their beliefs in light of the same information.

The study, published in Econometrica, was conducted by researchers at 糖心Vlog视频, Lehigh University, and the London School of Economics and Political Science (LSE).

鈥淓conomists have long used notions of underreaction and overreaction to explain puzzles in macroeconomics and finance, but have never reached consensus on why people underreact in some environments and overreact in others,鈥� notes Yucheng Liang, Assistant Professor of Accounting at Carnegie Mellon鈥檚 Tepper School of Business, who coauthored the study.

Liang and his coauthors analyzed two commonly studied problems related to updating beliefs: 1) an inference problem, in which an individual observes informative signals about an underlying state and updates their beliefs about the state, and 2) a forecast-revision problem, in which an individual observes the same signals but updates their beliefs about future outcomes that depend on the underlying state.

Participants underreacted to signals when inferring about underlying states, but overreacted to the same signals when revising forecasts about future outcomes鈥攁 phenomenon the authors call the inference-forecast gap. This gap was largely driven by different rules of thumb used in the two tasks, the study found, and may help explain the coexistence of under- and overreaction across settings.

鈥淥ur findings suggest that this discrepancy may arise because people consider some problems inference tasks and others forecast-revision tasks, leading them to approach the two in fundamentally different ways,鈥� explains Tony Q. Fan, Assistant Professor of Economics at Lehigh University鈥檚 College of Business, who led the study. 鈥淭his implies that to understand biased reactions to information in the field, it is essential to first understand how people mentally represent the belief-updating problem they face.鈥�

鈥淥ur work is related to an active body of experimental research that seeks to understand the conditions of underreaction and overreaction in updating beliefs,鈥� adds Cameron Peng, Assistant Professor of Finance at LSE, who coauthored the study. 鈥淲e show that the direction of belief-updating biases depends on the type of belief elicited and the nature of the question, and by connecting the inference-forecast gap to the use of different simplifying rules of thumb, we highlight the role of complexity and incorrect mental models in explaining belief-updating biases.鈥�

The study was funded by Carnegie Mellon, the Institute of Labor Economics, and LSE.

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Summarized from an article in Econometrica, 鈥�,鈥� by Fan, TQ (Lehigh University), Liang, Y (糖心Vlog视频), and Peng, C (London School of Economics and Political Science). Copyright 2026 The Authors. All rights reserved.
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