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Dropping rational expectations

Lionel de Boisdeffre

Mathematical Social Sciences, 2022, vol. 115, issue C, 37-46

Abstract: We consider a two-period pure-exchange economy, where uncertainty prevails and agents, possibly asymmetrically informed, exchange commodities and securities of all kinds. Consumers’ characteristics, anticipations, beliefs and actions are all private and typically not known nor assessed by the other agents. This setting drops rational expectations along the ‘common knowledge of rationality and market clearing’ (CKRMC) assumptions, and, in particular, it drops the Radner (1979) price model and price inference assumptions. Unaware agents are shown to face an incompressible uncertainty over future states and prices, represented by a so-called ”minimum uncertainty set”. A sequential equilibrium obtains when agents expect the ‘true’ price as a possible outcome on every spot market, and elect optimal market-clearing strategies. This so-called ”correct foresight equilibrium” (CFE) is shown to exist whenever agents’ anticipation sets include the minimum uncertainty set. When the CKRMC assumptions are restored, the CFE is shown to lead to an overarching concept of rational expectations equilibrium, which generalizes the classical concepts.

Keywords: Sequential equilibrium; Temporary equilibrium; Existence of equilibrium; Rational expectations; Asymmetric information; Arbitrage (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1016/j.mathsocsci.2021.12.005

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