The Rationality of Expectations Formation

Julio Dávila

The B.E. Journal of Theoretical Economics, 2016, vol. 16, issue 2, 515-543

Abstract: Rational expectations are not required to follow from beliefs that explain well history, but just to correctly foresee the future. As a consequence, at a rational expectations equilibrium, the agents’ expectations may follow from beliefs that explain poorly the observed history, even among those rationalizing their choices. This paper shows, firstly, that if agents hold rationally formed expectations instead – in the sense of following from beliefs that explain history better than any other beliefs justifying their choices – then allocations unsupported by rational expectations can be shown to be equilibrium outcomes. By means of this result, it is established, secondly, that adding the common knowledge of the rationality of the formation of expectations to that of the rationality of choices and of market clearing, still does not suffice to guarantee rational expectations. Finally, the rationally formed expectations equilibria produced in this paper exhibit a sunspot-like volatility that, interestingly enough, do not rely on an explicit sunspot mechanism.

Keywords: rationality; expectations; overlapping generations (search for similar items in EconPapers)
JEL-codes: D5 D84 E3 (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (1)

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Related works:
Working Paper: The rationality of expectations formation (2016)
Working Paper: The Rationality of Expectations Formation (2016)
Working Paper: The rationality of expectations formation (2014)
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DOI: 10.1515/bejte-2014-0082

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