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Structural stability and robustness to bounded rationality

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  • Anderlini, Luca
  • Canning, David

Abstract

The introduction of a small amount of bounded rationality into a model sometimes has little effect, and sometimes has a dramatic impact on predicted behavior. We call a model robust to bounded rationality if small deviations from rationality result only in small changes in the equilibrium set. We also say that a model is structurally stable if the equilibrium set (given fully rational agents) varies continuously with the parameter values of the model. Our notions of a model and of rationality are quite broad, allowing us to cover cases in which bounded rationality refers to imperfect optimization, non-rational expectations, or arbitrary behavior by a subset of agents. We show that a model is robust to bounded rationality if and only if it is structurally stable. Thus, we can characterize which models will be robust to bounded rationality and which ones will not, independently of the exact form that bounded rationality takes. In addition, from our characterization it follows that introducing a small amount of bounded rationality will have large effects on predicted outcomes if and only if parameters are near a critical point where the equilibrium set changes in a discontinuous way JEL classification: C69, C79, D51, E19

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Bibliographic Info

Paper provided by Economics Division, School of Social Sciences, University of Southampton in its series Discussion Paper Series In Economics And Econometrics with number 0002.

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Date of creation: 01 Jan 2000
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Handle: RePEc:stn:sotoec:0002

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  1. Russell, Thomas & Thaler, Richard, 1985. "The Relevance of Quasi Rationality in Competitive Markets," American Economic Review, American Economic Association, vol. 75(5), pages 1071-82, December.
  2. Antulio N. Bomfim & Francis X. Diebold, 1996. "Bounded Rationality and Strategic Complementarity in a Macroeconomic Model: Policy Effects, Persistence and Multipliers," NBER Working Papers 5482, National Bureau of Economic Research, Inc.
  3. Robert Wilson, 2010. "Computing Equilibria of n-person Games," Levine's Working Paper Archive 402, David K. Levine.
  4. Oh, Seonghwan & Waldman, Michael, 1994. "Strategic Complementarity Slows Macroeconomic Adjustment to Temporary Shocks," Economic Inquiry, Western Economic Association International, vol. 32(2), pages 318-29, April.
  5. Conlisk, John, 1980. "Costly optimizers versus cheap imitators," Journal of Economic Behavior & Organization, Elsevier, vol. 1(3), pages 275-293, September.
  6. Sethi, Rajiv & Franke, Reiner, 1995. "Behavioural Heterogeneity under Evolutionary Pressure: Macroeconomic Implications of Costly Optimisation," Economic Journal, Royal Economic Society, vol. 105(430), pages 583-600, May.
  7. Akerlof, George A & Yellen, Janet L, 1985. "Can Small Deviations from Rationality Make Significant Differences to Economic Equilibria?," American Economic Review, American Economic Association, vol. 75(4), pages 708-20, September.
  8. Evans, George W & Ramey, Garey, 1992. "Expectation Calculation and Macroeconomic Dynamics," American Economic Review, American Economic Association, vol. 82(1), pages 207-24, March.
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