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Intrinsic heterogeneity in expectation formation

  • Branch, William A.
  • Evans, George W.

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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Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 127 (2006)
Issue (Month): 1 (March)
Pages: 264-295

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Handle: RePEc:eee:jetheo:v:127:y:2006:i:1:p:264-295
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622869

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  1. Evans, George W & Ramey, Garey, 1992. "Expectation Calculation and Macroeconomic Dynamics," American Economic Review, American Economic Association, vol. 82(1), pages 207-24, March.
  2. William A. Brock & Steven N. Durlauf, 2001. "Discrete Choice with Social Interactions," Review of Economic Studies, Oxford University Press, vol. 68(2), pages 235-260.
  3. Brock, William A. & de Fontnouvelle, Patrick, 2000. "Expectational diversity in monetary economies," Journal of Economic Dynamics and Control, Elsevier, vol. 24(5-7), pages 725-759, June.
  4. William A. Brock & Cars H. Hommes, 1997. "A Rational Route to Randomness," Econometrica, Econometric Society, vol. 65(5), pages 1059-1096, September.
  5. Brock,W.A. & Hommes,C.H., 2001. "Evolutionary dynamics in financial markets with many trader types," Working papers 7, Wisconsin Madison - Social Systems.
  6. Branch, William A., 2002. "Local convergence properties of a cobweb model with rationally heterogeneous expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 27(1), pages 63-85, November.
  7. John Haltiwanger & Michael Waldman, 1989. "Limited Rationality and Strategic Complements: The Implications for Macroeconomics," The Quarterly Journal of Economics, Oxford University Press, vol. 104(3), pages 463-483.
  8. Brock, W.A. & Hommes, C.H., 1996. "Hetergeneous Beliefs and Routes to Chaos in a Simple Asset Pricing Model," Working papers 9621, Wisconsin Madison - Social Systems.
  9. Bray, Margaret M & Savin, Nathan E, 1986. "Rational Expectations Equilibria, Learning, and Model Specification," Econometrica, Econometric Society, vol. 54(5), pages 1129-60, September.
  10. Evans, George W. & Honkapohja, Seppo & Marimon, Ramon, 1996. "Convergence in Monetary Inflation Models with Heterogeneous Learning Rules," CEPR Discussion Papers 1310, C.E.P.R. Discussion Papers.
  11. Townsend, Robert M, 1983. "Forecasting the Forecasts of Others," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 546-88, August.
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