Rational Expectations Hypothesis Research Articles

Investment volatility during red sea crisis: Study in Asean country

The objective of this research is to investigate the volatility of investment instruments, with the aim of providing the best model for predicting investment value. In this topic, the main concepts and theories that underpin the research are presented. Efficient market hypothesis and rational expectations theory stand out, providing a solid basis for understanding the context of the investigation. The methodology adopted for this research GARCH modelling to analysis investment instrument and the impact of its volatility. Data collection was carried out through yahoo finance website and investing website during red sea war event. The research identified optimal GARCH models for different indexes and assets: GARCH (1,1) for JCI, STI, SET, and Bitcoin, E-GARCH (1,1) for KLSE, PSE, and VSE, and GJR-GARCH (1,1) for Gold. It discussed volatility persistence and leverage effects during the Red Sea War, considering model sensitivities, geopolitical impacts, and research limitations. This research's practical and theoretical implications inform financial risk management, highlighting the importance of robust volatility modeling. The findings can enhance portfolio optimization and investment strategies during geopolitical instability. These insights underscore the need for sophisticated approaches to manage financial risks effectively. This research uses advanced GARCH models to analyze volatility during the Red Sea Crisis, revealing asset-specific behaviors under geopolitical stress. The findings improve financial risk management and investment strategies in unstable conditions, enhancing volatility predictions and professional practices.

Investigation of Expected Inflation According to Adaptive Expectations Hypothesis Using Koyck Transformation: A Study on Türkiye

Inflation expectations have been researched theoretically and practically for more than a century and continue to be a favorite research topic for economists even today. The validity of the Rational Expectations Hypothesis has not yet been proven by empirical research, and many studies show that it is invalid. This situation drew attention again to the validity of the Adaptive Expectations Hypothesis. In this study, inflation expectations for Türkiye in the 2013m6-2023m7 period, under the assumption of the Adaptive Expectations Hypothesis, were tested first by applying the Nerlove (1958) model and secondly by applying the Koyck transformation within the framework of the Friedman-Cagan model. As a result of the study, although evidence was found that the Adaptive Expectations Hypothesis is valid in Türkiye according to the Nerlove (1958) model, it was observed that there was a weak relationship between actual inflation and expected inflation. The second model was applied to avoid hesitation in accepting the hypothesis. With the Koyck transform model, it has been determined that individuals in Türkiye learn from past inflation values in forming inflation expectations. The speed of this learning is 77%. It was concluded that individuals form their inflation expectations by using 77% of current and past inflation data. The intended history includes the current period, the first and second lags. In terms of expectations, the effect of the third lag is zero.

Subjective Well-Being of Chief Executive Officers and Its Impact on Stock Market Volatility During the COVID-19 Pandemic in Poland: Agent-Based Model Perspective

This study aimed to connect the behavioral corporate finance perspective (micro level) with complexity theory via agent-based modeling to analyze the impact of selected psychological factors of chief executive officers (CEOs) on stock market volatility (macro level). Specifically, we wanted to explore whether Polish CEOs’ subjective well-being (SWB) influenced their managerial decisions during the COVID-19 pandemic and how it might be related to the volatility of stock prices during this critical period in Poland. Our study was based on a survey of Polish CEOs who managed companies listed on the Warsaw Stock Exchange. In particular, 255 CEOs completed the Satisfaction with Life Scale, the Positive and Negative Affect Scale, and a business survey on the impact of the COVID-19 pandemic on company management. Using the results of this survey, we built an agent-based model to investigate how CEOs’ decision-making, stemming from their SWB levels, influences the perception of prices by individual traders and, in turn, how it is translated into aggregate stock market volatility. The results indicate the pathways through which the microscopic-level SWB of CEOs influences market price formation at a macroscopic level. The findings obtained from our model may shed new light on the rational expectations theory applied to stock market volatility during the financial crisis.

Impact of Monetary Policy on Stock Market Volatility

Purpose: The general objective of the study was to analyze the impact of monetary policy on stock market volatility. Methodology: The study adopted a desktop research methodology. Desk research refers to secondary data or that which can be collected without fieldwork. Desk research is basically involved in collecting data from existing resources hence it is often considered a low cost technique as compared to field research, as the main cost is involved in executive’s time, telephone charges and directories. Thus, the study relied on already published studies, reports and statistics. This secondary data was easily accessed through the online journals and library. Findings: The findings reveal that there exists a contextual and methodological gap relating to the impact of monetary policy on stock market volatility. Preliminary empirical review revealed that monetary policy exerts significant influence on stock market volatility through various channels such as interest rate adjustments, quantitative easing, and forward guidance. It highlighted that the timing and clarity of policy announcements play a crucial role in shaping market reactions, with unexpected shifts often leading to heightened volatility. Global interconnectedness amplified these effects, underscoring the need for coordinated policy responses. Behavioral factors also contributed, as investor sentiment and market psychology could magnify volatility independently of economic fundamentals. Understanding these dynamics is crucial for effective policy design and market stability amidst evolving financial landscapes. Unique Contribution to Theory, Practice and Policy: Efficient Market Hypothesis (EMH, Rational Expectations Theory and Keynesian Economics may be used to anchor future studies on monetary policy on stock market volatility. Recommendations from the study included integrating behavioral finance models into economic frameworks to enhance predictive accuracy. It advocated for clearer and more consistent central bank communications to align market expectations with policy actions, reducing uncertainty-driven volatility. Collaborative efforts among central banks were emphasized to manage international spillovers and enhance global financial stability. Adaptive policy frameworks were proposed to respond flexibly to changing market conditions while promoting regulatory measures to safeguard against excessive risk-taking. These recommendations aimed to foster a stable financial environment supportive of sustainable economic growth and market confidence.

Testing rational expectations in a cointegrated VAR with structural change

The rational expectation hypothesis is widely used in finance and macroeconomics. A research question investigates whether models using this hypothesis can fit the data well. Researchers have been developing econometric procedures to test rational expectation models. Sargent and Hansen (1991) proposed how to test exact rational expectation restrictions. This study aims to achieve three objectives. The first objective is to extend Johansen and Swensen’s framework that test exact rational expectation restrictions to the case where the data-generating process is a cointegrated vector autoregressive model with abrupt structural change (CVAR-SC). The second goal is to highlight that the type of rational expectation restrictions analysed in this paper imply co-breaking, as defined by Hendry and Mizon (1998). Finally, the restrictions on the CVAR-SC parameters implied by the present value model and expectation hypothesis of the interest rate term structure are analysed, derived and tested. Three empirical exercises are reported. The first is Engsted (2002)’s dataset on share prices and dividends, the second uses a Brazilian term structure data set and the third uses a North American term structure dataset.

Behavioral economics and the nature of neoclassical paradigm

Psychological observations are by now well integrated into economics, especially in the theory of finance, as can also be seen in the Nobel Prize awarded to Thaler. On the contrary, Simon’s attempt to reforge economic theory on the paradigm of bounded rationality failed. Starting from the birth of the neoclassical paradigm, we’ll describe the attempt to give it psychological foundations with a direct measurement of utility, then the axiomatic turn of the paradigm and its first anomalies. We’ll then sum up the debate on rationality, taking place in the group of economists led by Simon, which brought to the rational expectations hypothesis. Finally, we’ll discuss the development of behavioral economics and its progressive acceptance in economic theory. This historical reconstruction allows us to understand the actual hard core of the neoclassical paradigm and the growing need of the paradigm for practical flexibility that determines how to choose arguments, methods and evidence that can be useful to its development, including psychological ones.

Examining Inflation Expectations within Asian Economies: Application of Wavelet Quantile Analysis towards Assessing Monetary Policy Credibility

The relevance of rational expectations has generated a renewed interest in assessing the accuracy of monetary policy declarations. Despite the enduring principles of the rational expectations theory, a remarkably dependable central bank can alleviate inflation by skillfully managing inflation expectations, thus avoiding adverse effects on employment. This paper explores the complex relationship between inflation expectations, target inflation rates, and the credibility of monetary policy, emphasizing the importance of rule compliance and transparent communication for establishing public confidence in central banks. While the estimation processes the study utilizes wavelet-based quantile regression by investigating data from 1990q1 to 2021q4, with variations across selected countries. The credibility index (CI) is employed to instrument the dependability of monetary policies. Nevertheless, the results of this study indicate that Policy credibility has a significant impact on inflation expectations in Bangladesh and Sri Lanka, underscoring the importance of clear communication and institutional reforms. Different outcomes in India and considerable effects in Pakistan underscore the necessity of customized policy measures and communication strategies to address inflation and promote economic stability in South Asia.

From coordination devices to coordination failures: on the changing epistemology of sunspots since the 1970s

The widespread adoption of the rational expectations hypothesis in macroeconomics since the 1970s often overlooked the issue of coordinating individual decisions, particularly regarding expectations. How is common knowledge, essential for rational expectations equilibrium, established? When common knowledge supports multiple equilibria, how do expectations converge to a specific one? These questions have been central to sunspot literature, which emerged in the early 1980s. Initially regarded as essential coordination devices by David Cass and Karl Shell, the epistemological status of sunspots evolved with the introduction of competing models and the transition from overlapping generations to infinitely lived agent frameworks. Recently, advancements in sunspot theory, especially in financial crises and experimental economics, have begun to rehabilitate the original interpretation of sunspots as coordination devices. This evolution reflects the ongoing debate about expectation formation and coordination in macroeconomic theory.

The mediating effect of the COVID-19 pandemic on heuristic techniques and cognitive biases on investment decision-making

US investors’ behavioral finance and investment decision-making approach became a concern during the COVID-19 pandemic era as the capital market crashed. The study used mediation analysis to explain how or why the COVID-19 pandemic intervened in the causal association of behavioral finance concepts of heuristic techniques and cognitive biases on their investment decision-making. This causal research design study was based on 500 snowball-sampled US investors who answered self-constructed, validated, and reliability-tested Likert-scale quantitative variables measured through a first-party data collection approach. The results showed that the COVID-19 pandemic was a specific moderate to partial significant mediator on the low positive significant relationships between heuristic techniques and investment decision-making, and the COVID-19 pandemic was a specific moderate to full significant mediator on the low positive not significant relationships between cognitive biases and investment decision-making among US investors. From the point of view of behavioral finance, the COVID-19 pandemic situation clearly and significantly demonstrated how US investors used 75.6% heuristics techniques (calculated guesses based on prior knowledge) and 87.5% cognitive biases (unintentional errors in their worldview) to cause the crash of the capital market. These findings confirm the rational expectations theory.

Accrual and real earnings management by rumored takeover targets

In this study we find evidence of income-increasing accrual and real earnings management occurring up to two quarters prior to the initial publication of a takeover rumor. We also find that post-rumor earnings management depends on both its form (accrual or real) as well as whether the rumor eventuates, observing income-decreasing accrual earnings management when the rumor is not accurate. Moreover, cumulative measures of earnings management for the month prior to the rumor are significant predictors of rumor accuracy, while being negatively correlated to rumor date and long-run returns. We interpret results as being consistent with rational expectations theory and note how managerial motivations may adapt to the degree of takeover likelihood.

Peculiarity of Behavior of Economic Agents under Cognitive Constraints in a Semi-Open New Keynesian Model

The aim of the paper is to analyze changes and peculiarities of behavior of economic agents with bounded rationality in the New Keynesian model, in which imported equipment and technology are one of the factors of production, and households consume only domestic products. The formation of output gap and inflation expectations by agents is based on stationary values of these variables and on extrapolation of the latest available data on inflation and the output gap. The weight shares of agents applying these rules change endogenously. Histograms of the frequency distribution of the degree of buoyancy and the impulse responses of monetary policy shocks and technology shocks to the variables under study show that a less open economy tends to go through an economic cycle with a smaller amplitude than a more rigid economy. Analyses of the trade-offs between the volatility of inflation and the output gap at different parameter values in the Taylor rule show their non-linear nature (in contrast to standard models with rational expectations). An important result obtained in this analysis is that the rational expectations hypothesis is more consistent with a closed economy than with an open one.

Rational expectations: an approach of anticipated linear-quadratic social optima

Motivated by rational expectations theory, this paper studies a class of stochastic linear-quadratic dynamic optimisation problems involving a large number of weakly-coupled heterogeneous agents. Different from well-studied mean field games, these agents formalise a team with cooperation to minimise some social cost functional. Moreover, the state here evolves by some anticipated backward stochastic differential equation in which the terminal instead initial condition is specified and the anticipated terms are involved. Applying a so-called anticipated person-by-person optimality principle, we construct an auxiliary control problem for each agent based on decentralised information. The decentralised social strategy is derived by a class of new consistency condition systems, which are mean-field-type anticipated forward–backward stochastic differential delay equations (AFBSDDEs). The well-posedness of such consistency condition system is obtained via discounting method. The corresponding asymptotic social optimality is also verified as the population size goes to infinity.

An assessment on rational expectations and perception engineering in the cyber-capitalist age

In recent years, studies in economics have revealed that analyses in psychology, sociology, religion, and ethics have begun to describe trends in the markets, household preferences, entrepreneurships, and investor decisions. These studies are referred to be results of the critical dynamics put forward by the "Rational Expectations Theory." Although conditional rationality is widely assumed in economic analysis, the assumptions of rational expectations as a unique approach allow for new perspectives of bias on the perception engineering which is being realised through social media for both political or economic operations. Percepion engineering has become easy and widespread in this new age of cyber-capitalism in which artificilal intelligence (AI) based Management Information Systems (MIS) and IoT tend to dominate pervasively for economic, political or religious reasons. This study asserts that investment decisions, political tendencies and economic preferences may not be rational due to exposure to perception engineering through innovative technology of algorithms and social media. Therefore, in today's cyber-capitalist ecosystems, the generation of manipulated social consent has been incredibly enhanced by hacking, collecting, accumulating, changing, controlling, and disseminating information for propaganda and marketing purposes over social media. In this multidiscipinary study, perception engineering that has become a part of artificial intelligence-assisted social engineering processes, is concluded to be the key spoiler of rational expectations of economic agents. In this context, possible measures are developed and suggested.

A study of Fisher Effect in India.

In this paper, the relationship between nominal interest rate and inflation is analyzed based on Fisher Effect (FE) theory. As per FE theory, the difference between nominal interest rate and expected inflation is equal to real interest rate. The theory proposes that a rise in expected inflation can lead to positive impact on nominal interest rate when the real interest rate is constant. For analyzing FE, the inflation rate measures based on Core index, Wholesale Price Index (WPI) and Consumer Price Index (CPI) are considered. As per rational expectation hypothesis, the one-period-ahead inflation rate is considered as expected inflation (eInf). The interest rates (IR) associated with call money, treasury bills of 91- and 364-day maturities are considered. The study uses ARDL bounds testing approach and Granger causality test for analyzing the long-run relationship between eInf and IR. The study finds evidence for presence of cointegrating relationship between eInf and IR in India. Contrary to FE theory, the long-run relation between eInf and IR is found to be negative. The extent and significance of long-run relationship varies depending on measures of eInf and IR considered. Along with cointegration, the expected WPI inflation and interest rate measures also exhibit Granger causality in at least one direction. Although, the cointegration is not observed between expected CPI and IR, there exists Granger causality between these variables. This increasing disconnect between eInf and IR could be attributed to adoption of flexible inflation targeting framework, pursual of additional objectives by monetary authority, different sources and types of inflation, etc.

The Timing of Technology Adoption in Network Industries

This paper analyzes the effect of network externalities on firms’ timing of new technology adoption in a network industry. In a pre-commitment game under Cournot competition, network effects tend to accelerate the timing of the leader and the follower regarding their adoption dates: under the rational expectations hypothesis and also under the firms’ output commitment. However, while an increase in network effects tends to reduce the discrepancy between the optimal social timing of the new technology adoption and the market-driven time of adoption in the rational expectations model, the opposite occurs under the output commitment game.

Consequences to the Stock Market Caused by Currency Fluctuations: Jordanian Evidence

Purpose: The aim of this study is to examine the fluctuations in currency exchange in the stock market, as it relates to the Jordanian market. Theoretical framework: The study's main goal is to identify how Jordanian SMR changes in currency exchange are influenced. Thus, the rational expectations theory has been used in this study. This theory illustrates three key aspects that influence the decision to participate in the stock market, including the availability of information, prior experience, and human reason. Design/ methodology/approach: The study incorporates the quantitative design, in which, information was extracted from secondary sources i.e. Investing.com. The information has been compiled considering the exchange rates, stock market returns, and cotton prices, beginning in 2015 and ending in 2020. The analysis has been conducted with Granger Causality test, VAR, and ADF. Findings: The results of this study concludes that fluctuations of exchange rates do not impact changes in cotton prices and the returns of the Jordanian stock exchange. Research, Practical & Social implications: The study is limited to Jordan, as only Jordan’s cotton price and stock market return data have been gathered. In addition, the time period of consideration of data is confined from 2015 to 2019, limiting the study’s scope. Originality/Value: The study uses sensitivity analysis to investigate the robustness of the impacts of fluctuations in currency exchange in the stock market, as it relates to the Jordanian market.

Identifying the source of information rigidities in the expectations formation process

Coibion and Gorodnichenko (2015) provide a useful framework to test the null hypothesis of full-information rational expectations against two popular classes of information rigidities, sticky information (SI) and noisy information (NI). However, the observational equivalence of SI and NI in average forecast errors gives no power in the test for one against the other. We identify the source of information rigidities by estimating the equations for the average forecast errors and variance of forecasts. The results show the importance of both SI and NI, but favor a type of NI in which agents can quickly learn the underlying state.

SPECIFICS OF METHODOLOGY IN THE CLASSICAL AND NEOCLASSICAL 
 OF ECONOMIC THEORY

The classical direction of economic theory is the direction of economic thought, within which the emergence and development of a market system was first scientifically studied. It developed a coherent system of economic categories and laws based on the principle of non-intervention of the state in the market economy and support for competition. This direction is considered revolutionary, since its results are relevant at the present time. The neoclassical direction explores the behavior of the co-called economic man, who seeks to maximize income and minimize costs. The main categories of analysis are limiting values. Representatives of the neoclassical direction developed the theory of unit productivity, equilibrium theory, economic theory of welfare, theory of rational expectations and others.

Modern İktisat Okulları Açışından Makroekonomik Dengeye Ulaşmada Beklentilerin Rolü

New Classicals have developed “Rational Expectations Hypothesis”. This means all economic agents are rational, optimizing and maximizing; they all have access to full information for the decisions they will take, and they will predict future prices correctly, hence make correct maximizing decisions.
 Friedman and Monetarists came up with “Adaptive Expectations Hypothesis” assuming that the workers, when there is an inflation will err in the first period and keep their wages the same; but in the next period they will realize the exact magnitude of the price rise and the fall in their real wage, hence will raise their wages correspondingly. Thus, the effects of monetary policy in reducing unemployment below natural rate of unemployment point will live only for one period; the economy will return to natural rate of unemployment and money supply increase will have only raised prices and wages; with the value of real parameters the same as one period ago.
 New Keynesians have also accepted Rational Expectations Hypothesis, which is obviously contrary to the Keynesian assumptions in this regard, namely, systematic under-estimation of future prices on the part of workers, as well as uncertainty and non-ergodicity.
 Post-Keynesians presented their assumptions in “Heterogeneous Expectations Hypothesis”. According to Post-Keynesians, entrepreneurs are in a better position than workers to obtain full information and estimate future prices correctly. The workers are less knowledgeable and generally end up under-estimating future prices.

Industrial Development and Economic Growth Nexus in Nigeria

Purpose. Industrial development is crucial in converting all resources to humanity’s use and benefits. Economists observe that the development and utilisation of the industrial sector are essential in a country’s economic growth. Disaggregating the industrial sector into various components, this paper empirically analyses the performance of the industrial sector on economic growth in Nigeria over the 1970-2015 period. Hence, to evaluate the relationship between industrial development and economic growth in Nigeria. Design/Methodology. The paper adopted autoregressive distributed lag (ARDL) as the technique of data analysis. Findings and implications. The results further revealed that the coefficients of all industrial subsectors, such as manufacturing, solid minerals and crude petroleum and gas, have positive and statistically significant influences on economic growth in both the short and long run. Among the industrial subsectors, the crude petroleum and gas sector appears to be the highest driver of Nigerian economic growth compared to other industrial subsectors, showing that the Nigerian economy is still far from diversified. Limitations. Limitation emanates from the problem of missing data from the source of data on the variable labour. However, effort has been made to overcome this challenge by applying a two-year moving average gap for periods of missing data. This method conforms to the rational expectation hypothesis (Muth, 1961). Originality. The development of the industrial sector of any economy can be measured by the contribution of various components (Isiksal & Chimezie, 2016). It is expected that as an economy becomes transformed, the share of industrialisation should be increasing (UNECA, 2011). The examination of industrial sector performance involves its sectoral components.