Uncertainty, Panic, and Confidence Uncertainty, Panic, and Confidence

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July 16, 2012
8:30 a.m. - 7:00 p.m.
Connolly Center, 4th Floor
Federal Reserve Bank of Boston
600 Atlantic Avenue
Boston, MA 02210

The economic environment is inherently uncertain. However, in periods of crisis uncertainty tends to undermine confidence and has the potential to blossom into full-fledged economic panic. To put it another way, in periods of normal activity individuals are able to act with confidence in the state of the economy in spite of uncertainty, but in times of crisis this is not the case. Gaining a better understanding of the impact and determinants of uncertainty, panic, and confidence is therefore important for designing preventive policy as well as policy to restore confidence during a time of economic crisis.  In this conference we seek to bring together a broad set of social science perspectives on decisionmaking under uncertainty, determinants of the perception of uncertainty, and factors that are thought to trigger economic panic or, conversely, induce confidence.

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8:30–9:30 am Breakfast

Session 1: A Psychological Perspective on Uncertainty and Panic
Professor Elke Weber, Columbia University
Anat Bracha, The Federal Reserve Bank of Boston
Discussant: Professor Colin Camerer, California Institute of Technology

This session will discuss decisionmaking under uncertainty from psychological perspective: definition of uncertainty, its determinants and effects on behavior. During this session we will discuss panic and confidence in the context of uncertainty, how psychologists think of panic, and what they think triggers it. We will focus on what is missing in economic thinking about uncertainty and bubbles from the psychological point of view, and could macroeconomic conditions amplify or suppress subjective feeling of uncertainty or trigger panic?

11:00–11:30 Break

11:30–1:00 pm

Session 2: The Impact of Fragile Beliefs on Valuation
Professor Lars Hansen, University of Chicago
Discussant: Professor Alp Simsek, Harvard University

Many economic settings provide only weak historical evidence on which alternative statistical models might best be used to forecast the future. Even when such evidence is inconclusive, individual decisions require guesses about future economic opportunities, and these guesses are reflected in market outcomes. I explore the impact of formulations of ambiguity aversion and robustness nested within models of dynamic economies. I characterize when beliefs appear to be fragile due to the nature of historical evidence and the sensitivity of valuations to competing perspectives on the future.  I also explore when cautious behavior is likely to be prevalent in ways that capture what is commonly but perhaps wrongly attributed to excessive risk aversion.

1:00–2:30 Luncheon


Session 3: Natural Expectations, Macroeconomic Dynamics, and Asset Pricing
Professor David Laibson, Harvard University
Discussant: Professor Andrew Caplin, New York University

How does an economy behave if (1) fundamentals are truly hump-shaped, exhibiting momentum in the short run and partial mean reversion in the long run, and (2) agents do not know that fundamentals are hump-shaped and base their beliefs on parsimonious models that they fit to the available data? A class of parsimonious models leads to qualitatively similar biases and generates empirically observed patterns in asset prices and macroeconomic dynamics. First, parsimonious models will robustly pick up the short-term momentum in fundamentals but will generally fail to fully capture the long-run mean reversion. Beliefs will therefore be characterized by endogenous extrapolation bias and pro-cyclical excess optimism. Second, asset prices will be highly volatile and exhibit partial mean reversion—i.e., overreaction. Excess returns will be negatively predicted by lagged excess returns, P/E ratios, and consumption growth. Third, real economic activity will have amplified cycles. For example, consumption growth will be negatively auto-correlated in the medium run. Fourth, the equity premium will be large. Agents will perceive that equities are very risky when in fact long-run equity returns will co-vary only weakly with long-run consumption growth. If agents had rational expectations, the equity premium would be close to zero. Fifth, sophisticated agents—i.e., those who are assumed to know the true model—will hold far more equity than investors who use parsimonious models. Moreover, sophisticated agents will follow a counter-cyclical asset allocation policy. These predicted effects are qualitatively confirmed in U.S. data.

4:00–4:30 Break


Session 4: A Practitioner Perspective on Behavior during a Crisis
Christopher Blum, JPMorgan Chase & Co.
Bjorn Tuypens, Platinum Grove Asset Management, L.P. (PGAM)

Mr. Blum, the current Global Head of Equities who served as the head of the Behavioral Finance group at JPMorgan Chase until recently, and Mr. Tuypens, Co-Managing Principal and Chief Investment Officer at PGAM, will talk about the state of affairs and public sentiment during the recent financial crises in the US and Europe. The session will focus on how practitioners view market behavior during a crisis and what in their eyes triggers panic.

5:30–7:00 Reception

Work Experience

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