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Intrinsic Heterogeneity in Expectation Formation

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  • George Evans
  • William Branch

Abstract

We introduce the concept of a Misspecification Equilibrium to dynamic macroeconomics. Agents choose between a list of misspecified econometric models and base their selection on relative forecast performance. A Misspecification Equilibrium is an equilibrium stochastic process in which agents forecast optimally given their choices, with the forecasting model parameters and predictor proportions endogenously determined. For appropriate conditions on the exogenous driving process and the degree of feedback of expectations, the Misspecification Equilibrium will exhibit Intrinsic Heterogeneity. With Intrinsic Heterogeneity more than one misspecified model receives positive weight in the distribution of predictors across agents, even in the neoclassical limit in which only the most successful predictors are used.

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Bibliographic Info

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2003 with number 312.

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Date of creation: 01 Aug 2003
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Handle: RePEc:sce:scecf3:312

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Keywords: misspecification; heterogeneous beliefs; adaptive learning;

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