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The Rationality of Expectations Formation

Author

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  • Julio Dávila

    (CORE - Center of Operation Research and Econometrics [Louvain] - UCL - Université Catholique de Louvain = Catholic University of Louvain)

Abstract

Rational expectations are not required to follow from beliefs that explain well history, but just to correctly foresee the future. As a consequence, at a rational expectations equilibrium, the agents’ expectations may follow from beliefs that explain poorly the observed history, even among those rationalizing their choices. This paper shows, firstly, that if agents hold rationally formed expectations instead – in the sense of following from beliefs that explain history better than any other beliefs justifying their choices – then allocations unsupported by rational expectations can be shown to be equilibrium outcomes. By means of this result, it is established, secondly, that adding the common knowledge of the rationality of the formation of expectations to that of the rationality of choices and of market clearing, still does not suffice to guarantee rational expectations. Finally, the rationally formed expectations equilibria produced in this paper exhibit a sunspot-like volatility that, interestingly enough, do not rely on an explicit sunspot mechanism.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Julio Dávila, 2016. "The Rationality of Expectations Formation," Post-Print halshs-03096230, HAL.
    • Handle: RePEc:hal:journl:halshs-03096230
    DOI: 10.1515/bejte-2014-0082
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    Cited by:

    1. Chatterji, Shurojit & Kajii, Atsushi, 2023. "Decentralizability of efficient allocations with heterogeneous forecasts," Journal of Economic Theory, Elsevier, vol. 207(C).

    More about this item

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • D5 - Microeconomics - - General Equilibrium and Disequilibrium
    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles

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