Discussion paper
DP17768 Firm Expectations and News: Micro v Macro
To shed light on the expectation formation of firms, we use firm-level data and examine how expectations adjust to news. We classify news as either micro (firm-specific developments) or macro (information about the aggregate economy). Analyzing survey data from Italian and German firms, we consistently find that expectations overreact to micro news but underreact to macro news. Our empirical specification is based on a stylized model of `island illusion,' because of which firms systematically underestimate the importance of aggregate developments for their own performance. This illusion has aggregate implications, which we derive by embedding it into the canonical noisy-information model.
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