Adaptive Expectations Hypothesis

Definition of adaptive expectations hypothesis’

The hypothesis of adaptive expectations theory that States individuals are adjusting their expectations for the future based on recent past experiences and events. In Finance, this effect can force people to make investment decisions based on the direction of recent historical data, such as stock price or the rate of inflation and adjust the data (in their expectations) to predict activity or price.

Breaking adaptive expectations hypothesis

The hypothesis on adaptive expectations assumes that investors will adjust their expectations of future behavior based on past behavior. If the market began to decline, people will probably expect continuation of the trend, because that’s what he did in the recent past. The tendency to think this way can be harmful because it can cause people to lose sight of the long-term trend, and not focus on recent activity and it is expected that it will continue. In fact, many of the items recovered. If the person becomes too focused on recent actions, they can catch signs of fracture and could miss the opportunity.

Examples of adaptive expectations hypothesis

For example, before the bubble burst, housing prices were appreciating and have a tendency to increase for a considerable period of time in many geographical areas of the U.S. people focused on this fact, and assumed it would continue indefinitely, so that they are in debt and acquired assets under the assumption that the price returns to the mean was not possible, because it hasn’t occurred recently. The cycle turned and prices fell as the bubble burst.

As another example, if inflation over the last 10 years working in the 2-3% range, investors will use the inflation expectations that range when making investment decisions. Therefore, if recently temporary extreme fluctuations in inflation rates occurred, for example, costs of the phenomenon of inflation, investors will overestimate the movement of inflation in the future. The opposite will occur in demand and inflation.

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