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Are consistent expectations better than rational expectations ?

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  • Elliot Aurissergues

    () (PSE - Paris School of Economics)

Abstract

In this paper, I argue that agents may prefer learning a misspecified model instead of learning the rational expectation model. I consider an economy with two types of agent. Fundamentalists learn a model where endogenous variables depend on relevant exogenous variables whereas followers learn a model where endogenous variables are function of their lagged values. A Fundamentalist is like a DSGE econometrician and a follower is like a VAR econometrician. If followers (resp. fundamentalists) give more accurate forecasts, a fraction of fundamentalists (resp. followers) switch to the follower model. I apply this algorithm in a linear model. Results are mixed for rational expectations. Followers may dominate in the long run when there are strategic complementarities and high persistence of exogenous variables. When additionnal issues are introduced, like structural breaks or unobservable exogenous variable, followers can have a significant edge on fundamentalists. I apply the algortihm in three economic models a cobweb model, an asset price model and a simple macroeconomic model.

Suggested Citation

  • Elliot Aurissergues, 2017. "Are consistent expectations better than rational expectations ?," Working Papers hal-01558223, HAL.
  • Handle: RePEc:hal:wpaper:hal-01558223
    Note: View the original document on HAL open archive server: https://hal.archives-ouvertes.fr/hal-01558223v2
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    File URL: https://hal.archives-ouvertes.fr/hal-01558223v2/document
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    References listed on IDEAS

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    1. Milton Friedman, 1957. "Introduction to "A Theory of the Consumption Function"," NBER Chapters,in: A Theory of the Consumption Function, pages 1-6 National Bureau of Economic Research, Inc.
    2. Roger Guesnerie, 2005. "Assessing Rational Expectations 2: "Eductive" Stability in Economics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262072580, March.
    3. Hommes,Cars, 2015. "Behavioral Rationality and Heterogeneous Expectations in Complex Economic Systems," Cambridge Books, Cambridge University Press, number 9781107564978.
    4. Bullard, James & Suda, Jacek, 2016. "The stability of macroeconomic systems with Bayesian learners," Journal of Economic Dynamics and Control, Elsevier, vol. 62(C), pages 1-16.
    5. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1, July.
    6. Roger Guesnerie, 2001. "Assessing Rational Expectations: Sunspot Multiplicity and Economic Fluctuations," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262072076, March.
    Full references (including those not matched with items on IDEAS)

    Citations

    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Are consistent expectations better than rational expectations?
      by Christian Zimmermann in NEP-DGE blog on 2017-09-21 20:01:16

    More about this item

    Keywords

    cobweb model; consistent expectations; Adaptive learning;

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