The rationality of expectations formation and excess volatility
AbstractI establish, in simple deterministic overlapping generations economies, that if each agent holds rationally formed expectations in the sense that any other expectations justifying his choices imply a smaller likelihood for the history he observes with limited memory, then there are rationally formed expectations equilibria exhibiting an excess volatility that no rational expectations equilibrium can match. Given that the limited records or finite memory case may arguably be the relevant one from a positive viewpoint, this result suggests that the possibility of excess volatility as an equilibrium phenomenon has been downplayed by the use of the rational expectations hypothesis.
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Bibliographic InfoPaper provided by Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne in its series Documents de travail du Centre d'Economie de la Sorbonne with number b08019.
Length: 23 pages
Date of creation: Feb 2008
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Expectations; rationality; volatility.;
Other versions of this item:
- Julio Davila, 2008. "The rationality of expectations formation and excess volatility," UniversitÃ© Paris1 PanthÃ©on-Sorbonne (Post-Print and Working Papers) halshs-00261582, HAL.
- D51 - Microeconomics - - General Equilibrium and Disequilibrium - - - Exchange and Production Economies
- D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
- D91 - Microeconomics - - Intertemporal Choice - - - Intertemporal Household Choice; Life Cycle Models and Saving
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-04-15 (All new papers)
- NEP-DGE-2008-04-15 (Dynamic General Equilibrium)
- NEP-HPE-2008-04-15 (History & Philosophy of Economics)
- NEP-UPT-2008-04-15 (Utility Models & Prospect Theory)
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