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A Model of Near-Rational Exuberance

  • Evans, George
  • Bullard, James
  • Honkapohja, Seppo

We study how the use of judgement or “add-factors” in forecasting may disturb the set of equilibrium outcomes when agents learn using recursive methods. We isolate conditions under which new phenomena, which we call exuberance equilibria, can exist in a standard self-referential environment. Local indeterminacy is not a requirement for existence. We construct a simple asset pricing example and find that exuberance equilibria, when they exist, can be extremely volatile relative to fundamental equilibria.

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File URL: http://hdl.handle.net/10943/122
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Paper provided by Scottish Institute for Research in Economics (SIRE) in its series SIRE Discussion Papers with number 2009-11.

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Date of creation: 2009
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Handle: RePEc:edn:sirdps:122
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  1. Eli Ofek & Matthew Richardson, 2003. "DotCom Mania: The Rise and Fall of Internet Stock Prices," Journal of Finance, American Finance Association, vol. 58(3), pages 1113-1138, 06.
  2. Robert J. Shiller, 1980. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," NBER Working Papers 0456, National Bureau of Economic Research, Inc.
  3. Thomas Sargent & Noah Williams & Tao Zha, 2006. "The Conquest of South American Inflation," NBER Working Papers 12606, National Bureau of Economic Research, Inc.
  4. Ricardo J. Caballero, 1992. "Near-Rationality, Heterogeneity and Aggregate Consumption," NBER Working Papers 4035, National Bureau of Economic Research, Inc.
  5. Lars E.O. Svensson & Robert J. Tetlow, 2005. "Optimal Policy Projections," International Journal of Central Banking, International Journal of Central Banking, vol. 1(3), December.
  6. Sargent, Thomas J., 1991. "Equilibrium with signal extraction from endogenous variables," Journal of Economic Dynamics and Control, Elsevier, vol. 15(2), pages 245-273, April.
  7. James Bullard & George W. Evans & Seppo Honkapohja, 2008. "Monetary Policy, Judgment, and Near-Rational Exuberance," American Economic Review, American Economic Association, vol. 98(3), pages 1163-77, June.
  8. Lars E. O. Svensson, 2003. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 426-477, June.
  9. 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, vol. 22(8-9), pages 1235-1274, August.
  10. Benhabib, Jess & Farmer, Roger E.A., 1999. "Indeterminacy and sunspots in macroeconomics," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 6, pages 387-448 Elsevier.
  11. Sargent, Thomas J., 1993. "Bounded Rationality in Macroeconomics: The Arne Ryde Memorial Lectures," OUP Catalogue, Oxford University Press, number 9780198288695, December.
  12. Evans, George W. & Honkapohja, Seppo & Honkapohja, Seppo, 1994. "Learning, convergence, and stability with multiple rational expectations equilibria," European Economic Review, Elsevier, vol. 38(5), pages 1071-1098, May.
  13. Evans, George W. & Honkapohja, Seppo, 1999. "Learning dynamics," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 7, pages 449-542 Elsevier.
  14. Ottaviani, Marco & Sorensen, Peter Norman, 2006. "The strategy of professional forecasting," Journal of Financial Economics, Elsevier, vol. 81(2), pages 441-466, August.
  15. Lars E.O. Svensson, 2005. "Monetary Policy with Judgment: Forecast Targeting," NBER Working Papers 11167, National Bureau of Economic Research, Inc.
  16. Roger Lagunoff & Stacey L. Schreft, 1999. "Financial fragility with rational and irrational exuberance," Proceedings, Federal Reserve Bank of Cleveland, pages 531-567.
  17. Branch, William A. & McGough, Bruce, 2005. "Consistent expectations and misspecification in stochastic non-linear economies," Journal of Economic Dynamics and Control, Elsevier, vol. 29(4), pages 659-676, April.
  18. George W. Evans & Seppo Honkapohja, 1998. "Economic Dynamics with Learning: New Stability Results," Review of Economic Studies, Oxford University Press, vol. 65(1), pages 23-44.
  19. Reifschneider, David L. & Stockton, David J. & Wilcox, David W., 1997. "Econometric models and the monetary policy process," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 47(1), pages 1-37, December.
  20. Marcet, Albert & Sargent, Thomas J., 1989. "Convergence of least squares learning mechanisms in self-referential linear stochastic models," Journal of Economic Theory, Elsevier, vol. 48(2), pages 337-368, August.
  21. Lettau, Martin & Uhlig, Harald, 2002. "The Sharpe Ratio And Preferences: A Parametric Approach," Macroeconomic Dynamics, Cambridge University Press, vol. 6(02), pages 242-265, April.
  22. Laurence Ball, 2000. "Near-Rationality and Inflation in Two Monetary Regimes," Economics Working Paper Archive 435, The Johns Hopkins University,Department of Economics.
  23. repec:cup:macdyn:v:2:y:1998:i:3:p:287-321 is not listed on IDEAS
  24. Hommes, Cars & Sorger, Gerhard, 1998. "Consistent Expectations Equilibria," Macroeconomic Dynamics, Cambridge University Press, vol. 2(03), pages 287-321, September.
  25. Albert Marcet & Thomas J. Sargent, 1992. "Speed of convergence of recursive least squares learning with ARMA perceptions," Economics Working Papers 15, Department of Economics and Business, Universitat Pompeu Fabra.
  26. George A. Akerlof & Janet L. Yellen, 1985. "A Near-Rational Model of the Business Cycle, with Wage and Price Inertia," The Quarterly Journal of Economics, Oxford University Press, vol. 100(Supplemen), pages 823-838.
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