IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

Rational overconfidence and excess volatility in general equilibrium

  • Carsten Krabbe Nielsen

Rational beliefs (in the form of WAMS measures) are expectations which though consistent with empirical observations, may deviate from the true underlying probability measure under which data is generated.We provide results on, as well as a decomposition of, WAMS measures and use this to demonstrate that an agent that adopts a non-stationary rational belief is rationally overconfident.To apply the theory to models of general equilibrium, we introduce the concept of a sunspot rational beliefs structure which can be considered as the exogenously specified part of a state process with rational beliefs. As an application, we consider an continuous state space model where agents make production decision before knowing prices. Under rational beliefs, unlike under rational expectations, mistakes persist even though all agents make forecasts that are statistically consistent with the equilibrium process. Due to the correlation of subjective beliefs brought about by the sunspots, the equilibrium exhibits excess price volatility.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://repec.org/esLATM04/up.4302.1081967035.pdf
Download Restriction: no

Paper provided by Econometric Society in its series Econometric Society 2004 Latin American Meetings with number 157.

as
in new window

Length:
Date of creation: 11 Aug 2004
Date of revision:
Handle: RePEc:ecm:latm04:157
Contact details of provider: Phone: 1 212 998 3820
Fax: 1 212 995 4487
Web page: http://www.econometricsociety.org/pastmeetings.asp
Email:


More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Jose A. Scheinkman & Wei Xiong, 2003. "Overconfidence and Speculative Bubbles," Journal of Political Economy, University of Chicago Press, vol. 111(6), pages 1183-1219, December.
  2. Mark P. Taylor, 1995. "The Economics of Exchange Rates," Journal of Economic Literature, American Economic Association, vol. 33(1), pages 13-47, March.
  3. Guidolin, Massimo & Timmermann, Allan G, 2001. "Option Prices under Bayesian Learning: Implied Volatility Dynamics and Predictive Densities," CEPR Discussion Papers 3005, C.E.P.R. Discussion Papers.
  4. Cass, David & Shell, Karl, 1983. "Do Sunspots Matter?," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 193-227, April.
  5. Carsten Krabbe Nielsen, 1997. "Floating Exchange Rates Versus a Monetary Union Under Rational Beliefs: The Role of Endogenous Uncertainty," Discussion Papers 97-22, University of Copenhagen. Department of Economics.
  6. Hammond, Peter J, 1981. "Ex-ante and Ex-post Welfare Optimality under Uncertainty," Economica, London School of Economics and Political Science, vol. 48(191), pages 235-50, August.
  7. Carsten Krabbe Nielsen, 1995. "Rational Belief Structures and Rational Belief Equilibrium," Discussion Papers 95-14, University of Copenhagen. Department of Economics.
  8. Mordecai Kurz & Maurizio Motolese, . "Endogenous Uncertainty and Market Volatility," Working Papers 99005, Stanford University, Department of Economics.
  9. Ho-Mou Wu & Wen-Chung Guo, 2003. "Speculative trading with rational beliefs and endogenous uncertainty," Economic Theory, Springer, vol. 21(2), pages 263-292, 03.
  10. Dan Lovallo & Colin Camerer, 1999. "Overconfidence and Excess Entry: An Experimental Approach," American Economic Review, American Economic Association, vol. 89(1), pages 306-318, March.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:ecm:latm04:157. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christopher F. Baum)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.