Rational Expectation Formation Research Articles

The Role of Expectations on Exchange Rate Determination in Indonesia

There are two purposes of this paper. Firstly, it deals with expectation formation. Secondly, it will be tested whether the expectation has a significant role in determining the current exchange rate in the case of Indonesian currency against the US dollar and Euro. This research will compare two kinds of expectation formation. Firstly, the expectation built from the fundamental economy is known as rational expectation formation. Secondly, the expectation formulated from past time series information, the Auto Regressive Moving Average (ARMA) model, is utilized. The steps to prove the role of expectation are stationary process, degree of integration, co-integration, and U-Theil's Inequality Coefficient Test (UTIC). It is found that both kinds of expectation formation have essential roles in determining the current exchange rate in Indonesia. However, according to UTIC criteria, a rational expectation better explains both current exchange rate movements.

Expectations in an open economy hyperinflation: Evidence from Germany 1921–23

We reconsider the Beladi et al. (1993) technique to measure expectations in hyperinflation episodes by allowing money to be substitutable with foreign assets as well as goods. We determine new correctness conditions for adaptive and rational expectations formation in this context and show that, taking into account these conditions, the data for the German hyperinflation of the 1920s is consistent with rational expectation formation.

Rational expectations equilibria in a Ramsey model of optimal growth with non-local spatial externalities

This work provides a rigorous treatment concerning the formation of rational expectations equilibria in a general class of spatial economic models under the effect of externalities, using techniques from calculus of variations and optimal control. Using detailed estimates for a parametric optimisation problem, the existence of rational expectations equilibria is proved via a fixed-point theorem, and they are characterised in terms of a nonlocal Euler-Lagrange equation. The study of the individual optimisation problem, formulated according to Ramsey's model, is performed via a convex relaxation to the space of BV capital paths and measure-valued consumptions, and allows to obtain existence, uniqueness, regularity and stability properties for the optimisers in a rigorous and original way.

Behavioral Economic View: The Episode of Won/USDollar Exchange Rate during the Crisis

Background/Objectives: This paper is motivated by recent evidence that the relation between Korean Won-US Dollar exchange rate and US federal funds rate is time-varying unlike conventional belief on the relation. Methods/Statistical Analysis: We employ the rolling window approach to figure out the influence of the crisis on the relation between the Won/ US-Dollar exchange rate and the US interest rate. The rolling window approach is used in time series analysis especially when the available sample period is short. This approach can be applied in order to check the predictive performance using a finite number of windows within a considered time span. Findings: The evidences resulting from the rolling window approach show that the Won/US-Dollar exchange rate and the US interest rate appear to be negatively correlated in some periods and positively correlated in others. Those time-varying patterns in the relation between exchange rate and interest rate are difficult to be explained from the traditional view of uncovered interest parity. On the other hand, behavioral macroeconomic perspectives provide various explanations for theoretically unconventional finding in the context of rational expectation formation. Application/Improvements: Our empirical observation remains with the conjecture that investors’ fear near the crisis may lead to some anomaly. The latter hypothesis should be further studied by the behavioral macroeconomic view.

Inflation Expectations and the Stability of the Phillips Curve Relationship

We analyze the Phillips curve relationship in the euro area and the U.S. using monthly survey data on expected inflation. The dataset enables us to estimate models of the Phillips curve without assuming rational expectation formation. We find evidence for a Phillips curve relationship consistent with the theory. Furthermore, we show that the Phillips curve relationship is stable with structural regime switches which are of minor importance. Moreover, the Phillips curve relationship has been subject to switches in the shock volatilities.

The information content of the term structure of interest rates

This paper presents the results of an alternative test of the rational expectations theory of the term structure of interest rates. Other researchers have also examined the validity of the expectations hypothesis of term structure. While there is more often rejection of the expectations hypothesis, no other theory (data-consistent with the entire yield curve) provides an empirically adequate explanation of this phenomenon. The study considers postwar US pure discount (zero coupons) bond yields with various maturities, from one month to 60 months. Based on the ex post formation of rational expectations, the expectations error is quantified and the level of truth of the expectations hypothesis tested, that is, the strength of the departure of the yield curve from the expectations theory. The results suggest that a significant amount of information available at no cost to market agents is not incorporated in forming people's expectations.

TRAFFIC EQUILIBRIA WITH INCOMPLETE INFORMATION

This paper presents a new analytical framework for traffic equilibria with incomplete information. The basic element of our approach is differential information; different drivers have different information about their environment; they choose the routes based on their private (differentiated) information. Our purpose is to develop a general equilibrium model that makes explicit the information orthe beliefs that a driver has as part of his primitive characteristics. The model we present is a reinterpretation of Harsany's model of incomplete information game. The difference from Harsany's approach is the explicit consideration of the rational expectation formation by drivers. A numerical illustration may provide us a pedagogical insight on traffic equilibria with incomplete information.

Rational destabilizing speculation and exchange intervention policy

The fact that speculators might incorporate psychological factors in their stock market predictions, and be right in doing so, is a fundamental feature of most portfolio balance models postulating rational expectation formation. Here the so-called “extraneous-variable” problem is focused upon as a characterization of rational, but destabilizing speculation. Perfectly rational speculators cause the exchange rate to fluctuate more than would be warranted by market fundamentals. This characterization may be incomplete, as it involves a certain indeterminacy in the solution for the exchange rate. The implications for intervention policy are somewhat unconventional.

Labor contracts and monetary policy

Fischer and others have shown that the very existence of long-term contracts can imply a stabilization role for monetary policy in models that incorporate the natural rate hypothesis and rational expectation formation. The present paper examines some of the factors that determine the length of labor contracts and how they are affected by monetary policy. It is argued that a successful stabilization policy might be expected to increase the length of contracts. The net effect of the imposition of such a policy would therefore be to dampen the amplitude of business cycles, but to make them more inertia ridden.

Economically Rational Expectations: Are Innovations in the Rate of Inflation Independent of Innovations in Measures of Monetary and Fiscal Policy?

The concept of economically expectation formation is developed for a regime in which the acquisition and use of some information sets are nonnegligible. The concept provides a middle ground between autoregressive expectation formation and rational expectation formation. A necessary condition for the use of nonnegligible cost information sets is that such sets serve as leading indicators or more formally satisfy the causality conditions of Granger (1969). Using a time series modeling identification methodology developed by Box and Jenkins (1970) and Haugh (1972), we test the causal relationship between the rate of inflation and various monetary and fiscal aggregates. Surprisingly, we cannot reject the hypothesis that the rate of inflation is independent of the monetary and fiscal aggregates considered. Since the proposed leading indicator series contain no incremental predictive power once the information contained in the past history of inflation is efficiently utilized, we conclude that au...

RATIONAL EXPECTATIONS UNDER CONDITIONS OF COSTLY INFORMATION

ABSTRACTThis paper analyzes optimal formation of rational expectations where information is costly to obtain to utilize. Under these conditions, expectations normally formed by an estimator will be intermediate between those based on all available information and those which are optimal extrapolative predictors.1 Since the costs of information are likely to vary less than the value of information, this model can explain systematic differences in expectations in markets, such as, labor, for which the value of accuracy of expectations differs between or among buyers and sellers. Similarly, expectations about the same variable may differ between markets where arbitrage is also costly.Section I extends a model due to Theil toanalyzetheeffectsofcostlyinformation. Illustrative applications are discussed in Section II.

Rational Expectations Under Conditions of Costly Information

THIS PAPER ANALYZES optimal formation of rational expectations where information is costly to obtain to utilize. Under these conditions, expectations normally formed by an estimator will be intermediate between those based on all available information and those which are optimal extrapolative predictors.' Since the costs of information are likely to vary less than the value of information, this model can explain systematic differences in expectations in markets, such as, labor, for which the value of accuracy of expectations differs between or among buyers and sellers. Similarly, expectations about the same variable may differ between markets where arbitrage is also costly. Section I extends a model due to Theil to analyze the effects of costly information. Illustrative applications are discussed in Section II.