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On the Evolutionary Stability of Rational Expectations

  • William R. Parke

    ()

    (Department of Economics, University of North Carolina)

  • George A. Waters

    ()

    (Department of Economics, Illinois State University)

Evolutionary game theory provides a fresh perspective on the prospects that agents with heterogeneous expectations might eventually come to agree on a single expectation corresponding to the efficient markets hypothesis. We establish conditions where agreement on a unique forecast is stable, but also show that persistent heterogeneous expectations can arise if those conditions do not hold. The critical element is the degree of curvature in payoff weighting functions agents use to value forecasting performance. We illustrate our results in the context of an asset pricing model where a martingale solution competes with the fundamental solution for agents’ attention.

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File URL: http://economics.illinoisstate.edu/RePec/Papers/OESRE7-11.pdf
File Function: First version, 2011
Download Restriction: no

Paper provided by Illinois State University, Department of Economics in its series Working Paper Series with number 20111002.

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Length: 30 pages
Date of creation: Oct 2011
Date of revision:
Handle: RePEc:ils:wpaper:20111002
Contact details of provider: Web page: http://economics.illinoisstate.edu

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  10. Hommes, C.H., 2000. "Financial Markets as Nonlinear Adaptive Evolutionary Systems," CeNDEF Working Papers 00-03, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
  11. Wiliam Branch & George W. Evans, 2005. "Model Uncertainty and Endogenous Volatility," University of Oregon Economics Department Working Papers 2005-21, University of Oregon Economics Department, revised 26 Oct 2006.
  12. Evans, George W, 1991. "Pitfalls in Testing for Explosive Bubbles in Asset Prices," American Economic Review, American Economic Association, vol. 81(4), pages 922-30, September.
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  16. Constantinides, George M & Duffie, Darrell, 1996. "Asset Pricing with Heterogeneous Consumers," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 219-40, April.
  17. Hofbauer, Josef & Weibull, Jörgen W., 1995. "Evolutionary Selection against Dominated Strategies," Working Paper Series 433, Research Institute of Industrial Economics.
  18. George W. Evans & Roger Guesnerie, 1999. "Coordination on saddle path solutions: the eductive viewpoint," University of Oregon Economics Department Working Papers 2001-7, University of Oregon Economics Department, revised 15 May 2001.
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  23. Parke, William R. & Waters, George A., 2007. "An evolutionary game theory explanation of ARCH effects," Journal of Economic Dynamics and Control, Elsevier, vol. 31(7), pages 2234-2262, July.
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