Rational expectations and the econometric modeling of markets subject to uncertainty: A Bayesian approach

Abstract

Rational expectations theory is synthesized with Bayesian econometric theory to yield econometrically relevant models of competitive markets subject to uncertainty. The theory is used to derive both optimal estimators of the parameters of a Cobb-Douglas production function from time series data, and the equilibrium predictor of a future price. It is shown that a rational expectations price predictor is always an unbiased predictor, but that the converse is not true. It is also shown that the rational expectations equilibrium is a natural extension of the usual notion of a competitive equilibrium.