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On the Evolutionary Stability of Rational Expectations

Author

Listed:
  • William R. Parke

    () (Department of Economics, University of North Carolina)

  • George A. Waters

    () (Department of Economics, Illinois State University)

Abstract

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.

Suggested Citation

  • William R. Parke & George A. Waters, 2011. "On the Evolutionary Stability of Rational Expectations," Working Paper Series 20111002, Illinois State University, Department of Economics.
  • Handle: RePEc:ils:wpaper:20111002
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    File URL: http://economics.illinoisstate.edu/RePec/Papers/OESRE7-11.pdf
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    rational expectations; hetergeneous expectations; evolutionary game theory; asset pricing; efficient markets hypothesis;

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes

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