April, 2004

Does the Market Self-Correct? Asymmetrical Adjustment and the Structure of Economic Error - Working Paper

  • Christopher Coyne

    Associate Director, F. A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics
  • Peter J. Boettke

    Director, F. A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics
  • Peter Leeson

    Senior Fellow, F. A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics
Key materials
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Fernandez and Rodrik argue that agent errors in the political market will be overpessimistically biased and persistent. As a result, policy is inefficient.  This Working paper show how their argument can be extended to the economic market. In the economic arena, while both errors of overoptimism and errors of overpessimism are possible in the face of uncertainty, the presence of option value from deferring a decision to exchange causes trader errors to be overpessimistically biased. This is problematic because unlike errors of overoptimism, errors of overpessimism are not ‘automatically’ revealed to the agents who make them. Furthermore, owing to the "bad news principle of irreversible investment," these errors are likely to persist. In this working paper, Boettke, Leeson, and Coyne show that although persistent errors of overpessimism are likely to plague decisions in the political sphere, entrepreneurial activity in the market corrects them and prevents their persistence.