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Dynamic higher order expectations

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Abstract

In models where privately informed agents interact, agents may need to form higher order expectations, i.e. expectations of other agents' expectations. This paper develops a tractable framework for solving and analyzing linear dynamic rational expectations models in which privately informed agents form higher order expectations. The framework is used to demonstrate that the well-known problem of the infinite regress of expectations identified by Townsend (1983) can be approximated to an arbitrary accuracy with a finite dimensional representation under quite general conditions. The paper is constructive and presents a fixed point algorithm for finding an accurate solution and provides weak conditions that ensure that a fixed point exists. To help intuition, Singleton's (1987) asset pricing model with disparately informed traders is used as a vehicle for the paper.

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File URL: http://www.econ.upf.edu/docs/papers/downloads/1118.pdf
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Bibliographic Info

Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 1118.

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Date of creation: Oct 2007
Date of revision: Mar 2011
Handle: RePEc:upf:upfgen:1118

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Web page: http://www.econ.upf.edu/

Related research

Keywords: Dynamic Higher Order Expectations; Private Information; Asset Pricing;

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