Morning Must-Read: Noah Smith Reads Andrei Shleifer, Jeremy Greenwood, and Company on Trend-Chasing

Noah Smith: Does trend-chasing explain financial markets?: “Why do stock prices mean-revert in the long run?…

…Some people say that it’s because of time-varying risk premia with Rational Expectations; others say that it’s because of people’s incorrect information processing, and expectations are non-rational…. Andrei Shleifer and Robin Greenwood… take an extremely simple approach toward measuring people expectations: Just ask people what they think is going to happen!… Survey [expectations] measures are… strongly correlated… consistent with investors’ actions…. What causes people to expect higher stock returns?… Trend-chasing… seems to fit the facts very well…. Extrapolative Expectations beat Rational Expectations. That result would imply that trend-chasing by quasi-rational investors is the big force behind long-term stock return predictability…. But… [this] leaves the turning points unexplained…. There must be a role for hetergeneous investor expectations…. The refinement that Greenwood and Shleifer make in this 2013 paper, in which they team up with Nicholas Barberis and Lawrence Jin. They make a theoretical model where some investors are extrapolative trend-chasers and some are rational…