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Heterogeneous expectations and strong uncertainty in a Minskyian model of financial fluctuations

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  • Serena Sordi

    ()

  • Alessandro Vercelli

    ()

Abstract

We examine the role of expectations in a model aimed to explain financial fluctuations. The model restates the core of Minsky’s financial instability hypothesis, focusing on the role of expectations. The hypotheses concerning the process of formation and revision of expectations are discussed in light of Keynes’s epistemological view of the behaviour of boundedly rational agents under conditions of strong uncertainty. These hypotheses are formalized by drawing on recent advances in complex dynamics, decision theory and behavioural economics. We show that widespread use of extrapolative expectations by economic agents produces a high degree of financial instability that may lead to a serious financial crisis, and that the use by economic agents of a mix of extrapolative and regressive expectations reduces the dynamical instability of the model but may give rise to complex dynamics.

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Paper provided by Department of Economic Policy, Finance and Development (DEPFID), University of Siena in its series Department of Economic Policy, Finance and Development (DEPFID) University of Siena with number 1010.

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Date of creation: Dec 2010
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Handle: RePEc:usi:depfid:1010

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Keywords: financial instability; heterogeneous expectations; extrapolative expectations; regressive expectations; complex dynamics.;

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  1. Vercelli, Alessandro, 2000. "Structural financial instability and cyclical fluctuations," Structural Change and Economic Dynamics, Elsevier, Elsevier, vol. 11(1-2), pages 139-156, July.
  2. Levin, Jay H, 1997. "Chartists, Fundamentalists and Exchange Rate Dynamics," International Journal of Finance & Economics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 2(4), pages 281-90, October.
  3. Day, Richard H. & Huang, Weihong, 1990. "Bulls, bears and market sheep," Journal of Economic Behavior & Organization, Elsevier, Elsevier, vol. 14(3), pages 299-329, December.
  4. Ito, Takatoshi, 1990. "Foreign Exchange Rate Expectations: Micro Survey Data," American Economic Review, American Economic Association, American Economic Association, vol. 80(3), pages 434-49, June.
  5. Carl Chiarella & Roberto Dieci & Xue-Zhong He, 2008. "Heterogeneity, Market Mechanisms, and Asset Price Dynamics," Research Paper Series, Quantitative Finance Research Centre, University of Technology, Sydney 231, Quantitative Finance Research Centre, University of Technology, Sydney.
  6. Frank Westerhoff, 2006. "Samuelson's multiplier-accelerator model revisited," Applied Economics Letters, Taylor & Francis Journals, Taylor & Francis Journals, vol. 13(2), pages 89-92.
  7. Chiarella, Carl & Dieci, Roberto & He, Xue-Zhong, 2007. "Heterogeneous expectations and speculative behavior in a dynamic multi-asset framework," Journal of Economic Behavior & Organization, Elsevier, Elsevier, vol. 62(3), pages 408-427, March.
  8. Shinji Takagi, 1991. "Exchange Rate Expectations: A Survey of Survey Studies," IMF Staff Papers, Palgrave Macmillan, vol. 38(1), pages 156-183, March.
  9. Sonnemans, Joep & Hommes, Cars & Tuinstra, Jan & van de Velden, Henk, 2004. "The instability of a heterogeneous cobweb economy: a strategy experiment on expectation formation," Journal of Economic Behavior & Organization, Elsevier, Elsevier, vol. 54(4), pages 453-481, August.
  10. Sordi, Serena & Vercelli, Alessandro, 2006. "Financial fragility and economic fluctuations," Journal of Economic Behavior & Organization, Elsevier, Elsevier, vol. 61(4), pages 543-561, December.
  11. Alessandro Vercelli, 2011. "A Perspective on Minsky Moments: Revisiting the Core of the Financial Instability Hypothesis," Review of Political Economy, Taylor & Francis Journals, Taylor & Francis Journals, vol. 23(1), pages 49-67.
  12. Frank H. Westerhoff, 2008. "Heuristic Expectation Formation And Business Cycles: A Simple Linear Model," Metroeconomica, Wiley Blackwell, Wiley Blackwell, vol. 59(1), pages 47-56, 02.
  13. Reitz, Stefan & Westerhoff, Frank, 2003. "Nonlinearities and Cyclical Behavior: The Role of Chartists and Fundamentalists," CFS Working Paper Series 2003/10, Center for Financial Studies (CFS).
  14. Brock, William A. & Hommes, Cars H., 1998. "Heterogeneous beliefs and routes to chaos in a simple asset pricing model," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 22(8-9), pages 1235-1274, August.
  15. Westerhoff Frank H., 2006. "Nonlinear Expectation Formation, Endogenous Business Cycles and Stylized Facts," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, De Gruyter, vol. 10(4), pages 1-17, December.
  16. Lines, Marji & Westerhoff, Frank, 2010. "Inflation expectations and macroeconomic dynamics: The case of rational versus extrapolative expectations," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 34(2), pages 246-257, February.
  17. Frank H. Westerhoff, 2006. "Business Cycles, Heuristic Expectation Formation, and Contracyclical Policies," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 8(5), pages 821-838, December.
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Cited by:
  1. Passarella, Marco, 2011. "From the village fair to Wall Street. The Italian reception of Minsky’s economic thought," MPRA Paper 49593, University Library of Munich, Germany.
  2. Giansante, Simone & Chiarella, Carl & Sordi, Serena & Vercelli, Alessandro, 2012. "Structural contagion and vulnerability to unexpected liquidity shortfalls," Journal of Economic Behavior & Organization, Elsevier, Elsevier, vol. 83(3), pages 558-569.

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