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The rationality of expectations formation and excess volatility

  • Julio Davila

    ()

    (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics)

I establish, in simple deterministic overlapping generations economies, that if each agent holds rationally formed expectations in the sense that any other expectations justifying his choices imply a smaller likelihood for the history he observes with limited memory, then there are rationally formed expectations equilibria exhibiting an excess volatility that no rational expectations equilibrium can match. Given that the limited records or finite memory case may arguably be the relevant one from a positive viewpoint, this result suggests that the possibility of excess volatility as an equilibrium phenomenon has been downplayed by the use of the rational expectations hypothesis.

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Paper provided by HAL in its series Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) with number halshs-00261582.

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Date of creation: Feb 2008
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Handle: RePEc:hal:cesptp:halshs-00261582
Note: View the original document on HAL open archive server: https://halshs.archives-ouvertes.fr/halshs-00261582
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