The rationality of expectations formation and excess volatility

Julio Davila

Documents de travail du Centre d'Economie de la Sorbonne from Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne

Abstract: I establish, in simple deterministic overlapping generations economies, that if each agent holds rationally formed expectations in the sense that any other expectations justifying his choices imply a smaller likelihood for the history he observes with limited memory, then there are rationally formed expectations equilibria exhibiting an excess volatility that no rational expectations equilibrium can match. Given that the limited records or finite memory case may arguably be the relevant one from a positive viewpoint, this result suggests that the possibility of excess volatility as an equilibrium phenomenon has been downplayed by the use of the rational expectations hypothesis.

Keywords: Expectations; rationality; volatility. (search for similar items in EconPapers)
JEL-codes: D51 D84 D91 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-hpe and nep-upt
Date: 2008-02

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Related works:
Working Paper: The rationality of expectations formation and excess volatility (2008)
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Persistent link: http://EconPapers.repec.org/RePEc:mse:cesdoc:b08019

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