Firm Expectations and News: Micro v Macro
Philosophische Fakultät
Using firm-level data, we study how firm expectations adjust to news while accounting
for a) the heterogeneity of news and b) the heterogeneity of firms. We classify news
as either micro or macro, that is, information about firm-specific developments or
information about the aggregate economy. Survey data for German and Italian firms
allows us to reject rational expectations: Both types of news predict forecast errors at
the firm level. Yet while firm expectations overreact to micro news, they underreact to
macro news. We propose a general-equilibrium model where firms suffer from ‘island
illusion’ to explain these patterns in the data.
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