Corrective Overoptimism

Author: Brandon S.C. Chan (Department of Economics, Yale University, 2026)

Links: Manuscript PDF (47 pp.) · Online Appendix PDF (19 pp.) · Replication Appendix PDF (5 pp.) · Technical Digest

Abstract

Booms in infrastructure investment often coincide with investor exuberance and losses, yet the infrastructure remains long after these episodes. I show that investor overoptimism can correct for a general class of market failure: agents with diagnostic expectations over-extrapolate good news and conduct irreversible investments, pushing what was once a market failure toward the efficient level. This mechanism – corrective overoptimism – is embedded in a dynamic spatial model with endogenous infrastructure and estimated on data from England and Wales, 1700–1881, spanning the canal and railway booms. Corrective overoptimism can be a potent channel for growth.

JEL Classification: D84, E22, E32, N73, O18, O33, R12, R42