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A Rational Route to Randomness

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  • William A. Brock
  • Cars H. Hommes

Abstract

Adaptively rational equilibrium is introduced, where agents adapt their beliefs by choosing from a finite set of predictor functions. Agents make a rational predictor choice, based upon a publically available performance measure such as realized past profits. This results in an adaptive belief system, where predictor choice is coupled to the market equilibrium dynamics. As a typical example, the cobweb model with rational versus naive expectations is analyzed. If the market is locally unstable and rational expectations are costly to obtain, a high intensity of choice for predictor selection leads to chaos and strange attractors.

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Bibliographic Info

Article provided by Econometric Society in its journal Econometrica.

Volume (Year): 65 (1997)
Issue (Month): 5 (September)
Pages: 1059-1096

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Handle: RePEc:ecm:emetrp:v:65:y:1997:i:5:p:1059-1096

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  1. Hommes, Cars H., 1994. "Dynamics of the cobweb model with adaptive expectations and nonlinear supply and demand," Journal of Economic Behavior & Organization, Elsevier, vol. 24(3), pages 315-335, August.
  2. de Vilder, Robin, 1996. "Complicated Endogenous Business Cycles under Gross Substitutability," Journal of Economic Theory, Elsevier, vol. 71(2), pages 416-442, November.
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  7. Antonio Cabrales & Takeo Hoshi, 1993. "Heterogeneous beliefs, wealth accumulation and asset price dynamics," Economics Working Papers 55, Department of Economics and Business, Universitat Pompeu Fabra, revised Jun 1993.
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  13. Sethi, Rajiv, 1996. "Endogenous regime switching in speculative markets," Structural Change and Economic Dynamics, Elsevier, vol. 7(1), pages 99-118, March.
  14. Carl Chiarella, 1992. "The Dynamics of Speculative Behaviour," Working Paper Series 13, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
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