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Dropping rational expectations

Author

Listed:
  • Lionel De Boisdeffre

    (Centre d'Economie de la Sorbonne & CATT - Université de Pau)

Abstract

We had proposed earlier a general equilibrium model with incomplete financial markets and asymmetric information, where agents forecasted prices privately without rational expectations. Consistently, they anticipated idiosyncratic sets of future prices and elected probability laws on these sets, that we called beliefs. Under mild conditions and differently from Hart [1975] and Radner [1979] equilibrium always existed in this model, as long as agents' anticipations precluded arbitrage. The joint determination of equilibrium prices and beliefs is traditionally seen as a rational expectation problem. Hereafter, we suggest it may be otherwise. We propose to show that agents, whose prior anticipation sets yield an arbitrage, may update their expectations from observing trade opportunities on financial markets. With no price to be observed, they eventually infer smaller arbitrage-free anticipation sets, which can not be narrowed down any further. Once these sets are attained, equilibrium prices may change if agents change their beliefs, but they will convey the same information

Suggested Citation

  • Lionel De Boisdeffre, 2015. "Dropping rational expectations," Documents de travail du Centre d'Economie de la Sorbonne 15038, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne.
    • Handle: RePEc:mse:cesdoc:15038
    as

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    File URL: ftp://mse.univ-paris1.fr/pub/mse/CES2015/15038.pdf
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    References listed on IDEAS

    as
    1. Bernard Cornet & Lionel Boisdeffre, 2009. "Elimination of arbitrage states in asymmetric information models," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 38(2), pages 287-293, February.
    2. Radner, Roy, 1979. "Rational Expectations Equilibrium: Generic Existence and the Information Revealed by Prices," Econometrica, Econometric Society, vol. 47(3), pages 655-678, May.
    3. Cornet, Bernard & De Boisdeffre, Lionel, 2002. "Arbitrage and price revelation with asymmetric information and incomplete markets," Journal of Mathematical Economics, Elsevier, vol. 38(4), pages 393-410, December.
    4. Radner, Roy, 1972. "Existence of Equilibrium of Plans, Prices, and Price Expectations in a Sequence of Markets," Econometrica, Econometric Society, vol. 40(2), pages 289-303, March.
    5. Hart, Oliver D., 1975. "On the optimality of equilibrium when the market structure is incomplete," Journal of Economic Theory, Elsevier, vol. 11(3), pages 418-443, December.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Anticipations; inferences; perfect foresight; existence problem; rational expectations; financial markets; asymmetric information; arbitrage;
    All these keywords.

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets

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