Rationally Uncertain Expectations

Abstract

When financial securities are modeled as claims on stochastic processes, each trader’s beliefs at time can be summarized by a subjective probability distribution . The dominant Rational Expectations approach typically treats as a singleton that correctly gauges risks. In reality, financial risks are too unstable to squeeze out reasonable doubt. Rational learning can generate behavior that looks turbulently myopic although all it really indicates is high responsiveness to news. While Rational Expectations provides better insights than notions of unquantifiable expectations, it faces a mounting behaviorist critique. Rationally Uncertain Expectations accounts for a broader gamut of evidence with fewer internal contradictions.