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Intrinsic Heterogeneity in Expectation Formation

  • Bill Branch

    (College of William and Mary)

  • George W. Evans

    ()

    (University of Oregon Economics Department)

We introduce the concept of a Misspecification Equilibrium to dynamic macroeconomics. Agents choose between a list of misspecified econometric models and base their selection on relative forecast performance. A Misspecification Equilibrium is an equilibrium stochastic process in which agents forecast optimally given their choices, with the forecasting model parameters and predictor proportions endogenously determined. For appropriate conditions on the exogenous driving process and the degree of feedback of expectations, the Misspecification Equilibrium will exhibit Intrinsic Heterogeneity. With Intrinsic Heterogeneity more than one misspecified model receives positive weight in the distribution of predictors across agents, even in the neoclassical limit in which only the most successful predictors are used.

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Paper provided by University of Oregon Economics Department in its series University of Oregon Economics Department Working Papers with number 2003-32.

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Length: 30
Date of creation: 16 May 2003
Date of revision: 04 Oct 2004
Handle: RePEc:ore:uoecwp:2003-32
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