Cars Hommes – How Expectations Interact to Create Bubbles

How do economists make their models work. By assuming that investors have rational expectations and that every market participant is alike. However, things quickly get messy once economists start to acknowledge that people are different, interact with each other, and change heuristic forecasting strategies based on recent performance.

Cars Hommes navigates through the mess. He employs laboratory experiments with human subjects and fits complex models to empirical data with the goal of understanding whether introducing more financial derivatives can stabilize or destabilize markets and how the interaction between agents with heterogeneous expectations affects price dynamics in the housing market. Suddenly, theory gets much closer to reality.