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The Qualitative Expectations Hypothesis: Model Ambiguity, Consistent Representations of Market Forecasts, and Sentiment

Author

Listed:
  • Roman Frydman

    (Department of Economics, New York University)

  • Søren Johansen

    (University of Copenhagen and CREATES)

  • Anders Rahbek

    (University of Copenhagen)

  • Morten Nyboe Tabor

    (University of Copenhagen)

Abstract

We introduce the Qualitative Expectations Hypothesis (QEH) as a new approach to modeling macroeconomic and financial outcomes. Building on John Muth's seminal insight underpinning the Rational Expectations Hypothesis (REH), QEH represents the market's forecasts to be consistent with the predictions of an economist's model. However, by assuming that outcomes lie within stochastic intervals, QEH, unlike REH, recognizes the ambiguity faced by an economist and market participants alike. Moreover, QEH leaves the model open to ambiguity by not specifying a mechanism determining specific values that outcomes take within these intervals. In order to examine a QEH model's empirical relevance, we formulate and estimate its statistical analog based on simulated data. We show that the proposed statistical model adequately represents an illustrative sample from the QEH model. We also illustrate how estimates of the statistical model's parameters can be used to assess the QEH model's qualitative implications.

Suggested Citation

  • Roman Frydman & Søren Johansen & Anders Rahbek & Morten Nyboe Tabor, 2017. "The Qualitative Expectations Hypothesis: Model Ambiguity, Consistent Representations of Market Forecasts, and Sentiment," CREATES Research Papers 2017-23, Department of Economics and Business Economics, Aarhus University.
    • Handle: RePEc:aah:create:2017-23
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    References listed on IDEAS

    as
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    Cited by:

    1. Frydman, Roman & Stillwagon, Joshua R., 2018. "Fundamental factors and extrapolation in stock-market expectations: The central role of structural change," Journal of Economic Behavior & Organization, Elsevier, vol. 148(C), pages 189-198.

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    More about this item

    Keywords

    Asset-Price Movements; Model Ambiguity; Models with Time-Varying Parameters; REH; Behavioral Finance; GAS Models;
    All these keywords.

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • C65 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Miscellaneous Mathematical Tools
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation

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