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A Rational Route to Randomness

  • William A. Brock
  • Cars H. Hommes

Adaptively rational equilibrium is introduced, where agents adapt their beliefs by choosing from a finite set of predictor functions. Agents make a rational predictor choice, based upon a publically available performance measure such as realized past profits. This results in an adaptive belief system, where predictor choice is coupled to the market equilibrium dynamics. As a typical example, the cobweb model with rational versus naive expectations is analyzed. If the market is locally unstable and rational expectations are costly to obtain, a high intensity of choice for predictor selection leads to chaos and strange attractors.

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Article provided by Econometric Society in its journal Econometrica.

Volume (Year): 65 (1997)
Issue (Month): 5 (September)
Pages: 1059-1096

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Handle: RePEc:ecm:emetrp:v:65:y:1997:i:5:p:1059-1096
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  1. Sethi, Rajiv, 1996. "Endogenous regime switching in speculative markets," Structural Change and Economic Dynamics, Elsevier, vol. 7(1), pages 99-118, March.
  2. Jean-Michel Grandmont, 1998. "Expectations Formation and Stability of Large Socioeconomic Systems," Econometrica, Econometric Society, vol. 66(4), pages 741-782, July.
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  8. William A. Brock & Blake D. LeBaron, 1995. "A Dynamic Structural Model for Stock Return Volatility and Trading Volume," NBER Working Papers 4988, National Bureau of Economic Research, Inc.
  9. Grandmont Jean-michel, 1983. "On endogenous competitive business cycles," CEPREMAP Working Papers (Couverture Orange) 8316, CEPREMAP.
  10. Benhabib, Jess & Day, Richard H., 1982. "A characterization of erratic dynamics in, the overlapping generations model," Journal of Economic Dynamics and Control, Elsevier, vol. 4(1), pages 37-55, November.
  11. Hommes, Cars H., 1994. "Dynamics of the cobweb model with adaptive expectations and nonlinear supply and demand," Journal of Economic Behavior & Organization, Elsevier, vol. 24(3), pages 315-335, August.
  12. de Vilder, Robin, 1996. "Complicated Endogenous Business Cycles under Gross Substitutability," Journal of Economic Theory, Elsevier, vol. 71(2), pages 416-442, November.
  13. Marcet, Albert & Sargent, Thomas J, 1989. "Convergence of Least-Squares Learning in Environments with Hidden State Variables and Private Information," Journal of Political Economy, University of Chicago Press, vol. 97(6), pages 1306-22, December.
  14. Blume, Lawrence & Easley, David, 1992. "Evolution and market behavior," Journal of Economic Theory, Elsevier, vol. 58(1), pages 9-40, October.
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  16. Lux, Thomas, 1995. "Herd Behaviour, Bubbles and Crashes," Economic Journal, Royal Economic Society, vol. 105(431), pages 881-96, July.
  17. Kurz, Mordecai, 1994. "On Rational Belief Equilibria," Economic Theory, Springer, vol. 4(6), pages 859-76, October.
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