Rational beliefs and endogenous uncertainty

Economic Theory, 1994

The paper proposes that the theory of expectations be reformulated under the assumption that agents do not know the structural relations (such as equilibrium prices) of the economy. Instead, we postulate that they can observe past data of the economy and form probability beliefs based on the data generated by the economy. Using past data agents can compute relative frequencies and the basic assumption of the theory is that the system which generates the data is stable in the sense that the empirically computed relative frequencies converge. It is then shown that the limit of these relative frequencies induce a probability on the space of infinite sequences of the observables in the economy. This probability is stationary. A belief of an agent is a probability on the space of infinite sequences of the observable variables in the economy. Such a probability represents the "theory" or "hypothesis" of the agent about the mechanism which generates the data. A belief is said to be compatible with the data if under the proposed probability belief the economy would generate the same limit of the relative frequencies as computed from the real data. A theory which is "compatible with the data" is a theory which cannot be rejected by the data. A belief is said to be a Rational Belief if it is (i) compatible with the data and (ii) satisfies a certain technical condition. The Main Theorem provides a characterization of all Rational Beliefs.

Economic Theory, 2010

Papers in this symposium were presented at a Stanford University conference on August 10-14, 2009 entitled "When Are Diverse Beliefs Central?" They reflect the rapidly growing literature on the impact of diverse beliefs. It may thus be helpful to the reader if I use this introduction to highlight some ideas of this literature as reflected in the papers of this volume. As the era of Rational Expectations (in short RE) comes to a close it is important to clarify two points. First, the success of RE in disciplining macroeconomic modeling should not obscure the fact that the term "rational" is merely a label. Rationality of actions and rationality of beliefs have little to do with each other and using the term "rational" in RE has tended to brand other beliefs as "irrational." Studying axioms of belief rationality is actually a fruitful area of research that can fill the wide open space between RE and true irrational beliefs. A second point relates to private information. Not wishing to contradict RE, many adopted the device of asymmetric private information as the "cause" of diverse beliefs. Indeed, some view diverse beliefs as equivalent to asymmetric information. This is theoretically and empirically the wrong solution and in Kurz (2008, 2009) I explain why. It suffices to say that in large markets behavior under private information is different from behavior under diverse beliefs with common information. Also, all empirical evidence associates diverse forecasts with diverse modeling or diverse interpretation of public information. Finally, due to stochastic independence of private information over agents and time, RE models with asymmetric private information fail to deliver the key dynamic properties that are the central implications of I thank George Evans, Carsten Nielsen, Volker Wieland and Mike Wolters for constructive comments on earlier drafts of this Introduction.

Economic Theory, 1994

We study equilibria in which agent's belief are rational in the sense of Kurz 1-1994]. The market is formulated by specifying a stochastic demand function and a continuum of producers, each with a quadratic cost function who must select their output before knowing prices. Holding Rational Beliefs about future prices, producers maximize expected profits. In a Rational Belief Equilibrium (RBE) agents select diverse forecast functions but each one is rational in ~e sense that it is based on a theory which cannot be rejected by the data. It is shown that there exists a continuum of RBE's and they could entail very different patterns of time series for the economy and consequently different aggregate levels of longterm volatility. Since the model contains exogenously specified random variables, the difference in the level of long-term volatility of prices among the different RBE's arises endogenously as an "amplification" of the volatility of exogenous variables. The paper derives exact bounds on the possible levels of such "amplification."

2001

While Rational Expectations have dominated the paradigm of expectations formation, they have been more recently challenged on the empirical ground such as, for instance, in the dynamics of the exchange rate. This challenge has led to the introduction of heterogeneous expectations in economic modeling. More specifically, the forecasts of the market participants have been drawn from competing views. Two behaviours are usually considered: agents are either fundamentalist or chartist.

Economics and Philosophy, 2018

The standard, Bayesian account of rational belief and decision is often argued to be unable to cope properly with severe uncertainty, of the sort ubiquitous in some areas of policy making. This paper tackles the question of what should replace it as a guide for rational decision making. It defends a recent proposal, which reserves a role for the decision maker's confidence in beliefs. Beyond being able to cope with severe uncertainty, the account has strong normative credentials on the main fronts typically evoked as relevant for rational belief and decision. It fares particularly well, we argue, in comparison to other prominent non-Bayesian models in the literature.

This paper introduces heterogeneous beliefs and studies the implications for the existence of monetary equilibria, and its dynamic properties, in the monetary economy of Lagos and Wright (2005). An endogenous fraction of agents hold rational expectations and the remaining agents employ an adaptive learning rule similar to Evans and Honkapohja (2001) and Brock and Hommes (1997). Our model delivers three primary results that follow from the finding that heterogeneous beliefs can destabilize a stationary monetary equilibrium and lead to non-linear dynamics bounded around the monetary steady state. First, heterogeneous beliefs can lead to equilibria that are welfare reducing due, in part, to a lower acceptance rate in decentralized meetings. Second, when buyers, who are uncertain about their beliefs, behave like a Bayesian by placing a prior on sellers' beliefs, uncertainty impacts dynamic stability and welfare. Third, the model's unique predictions provide an explanation of new findings about the acceptance rate in monetary laboratory experiments.

Knowledge, Beliefs and Economics, 2006

HAL (Le Centre pour la Communication Scientifique Directe), 2002

While Rational Expectations have dominated the paradigm of expectations formation, they have been more recently challenged on the empirical ground such as, for instance, in the dynamics of the exchange rate. This challenge has led to the introduction of heterogeneous expectations in economic modeling. More specifically, the forecasts of the market participants have been drawn from competing views. Two behaviours are usually considered: agents are either fundamentalist or chartist. Moreover, the possibility of switching from one behaviour to the other one is also assumed. In a simple cobweb model, we study the dynamics associated with different endogenous switching process based on the path of prices. We provide an example with an asymmetric endogenous switching process built on the dynamics of past prices. This example confirms the widespread belief that fundamentalist market behaviour as compared with that of chartist tends to promote market stability.

International Journal of Social Economics, 2008

Abstract Purpose – This paper aims to reply to Dequech’s comment in the International Journal of Social Economics on the analysis of the formation of conventional expectations under strong uncertainty, which was proposed in the present author’s 2004 article in the International Journal of Social Economics. Design/methodology/approach – The scope of this reply is to evaluate through a theoretical examination the validity of Dequech’s claim contained in his comment that his initial analytical scheme of the state of expectations presented in his 1999 article was general enough to accommodate the psychological considerations, which were raised in the present author’s 2004 article and which were associated with Keynes’s analysis as well as with developments in the field of social psychology. Findings – The paper demonstrates that both Dequech’s initial article of the state of expectations and his subsequent comment on the present author’s contribution on the conventional formation of expectations under strong uncertainty in the International Journal of Social Economics overlooked the psychological nature of the process of inferences, a fundamental factor in Keynes’s discussion of the formation of conventional expectations. However, when social psychology considerations are introduced in the analysis (as it was the case with the present author’s approach) and when the remarkable theoretical and empirical progress in the field of social psychology is taken into account, Dequech’s claim of the generality of his framework is not justifiable because both the specific nature and the substantive impact of the social psychology issues associated with the role of inferences are overlooked across his analysis. It is proposed that a theoretical scheme that uses the wealth of evidence of contemporary social psychology is more promising for a rigorous development of a theory of expectations under strong uncertainty. Originality/value – The paper sheds further light on expectancy theory. Keywords Social psychology, Uncertainty management, Social economics Paper type Conceptual paper

SSRN Electronic Journal, 2000

Economic modeling assumes, for the most part, that agents are Bayesian, that is, that they entertain probabilistic beliefs, objective or subjective, regarding any event in question. We argue that the formation of such beliefs calls for a deeper examination and for explicit modeling. Models of belief formation may enhance our understanding of the probabilistic beliefs when these exist, and may also help up characterize situations in which entertaining such beliefs is neither realistic nor necessarily rational. * Our thinking on these issues was greatly influenced by discussions with many people. Gilboa and