Rational Expectations Hypothesis Research Articles

Developers land sale bidding strategy and house price expectation formation

ABSTRACTThis paper studies developers’ bidding strategy in Hong Kong’s land sale market where aggressive bidding is commonly seen. Given that the difference between the submitted bid and the estimated land value can be explained by the developer’s housing market outlook, the formation of house price expectation represents a tool to understand developers’ bidding strategy. Different economic expectation models are tested. While the rational expectation hypothesis (REH) is rejected, the proposed adaptive implicit expectation model best describes developers’ expectations. The findings in this paper provide land policymakers with insights on controlling the outcome of land sales as well as fill the gap of the house price expectation formation which remains little known.

Rational Expectations Theorists Rely Completely on the Fallacy of Conditional Apriorism (Long Runism), First Introduced by Charles Sanders Pierce and Hans Reichenbach in Their Objective Limiting Frequency Interpretations of Probability: No Frequentist Hypothesis Test Can Ever Lead to the Acceptance of the Rational Expectations Hypothesis

All Rational Expectation Theorists rely on the Fallacy of Conditional Apriorism (Long Runism)in order to operationalize the Objective Limiting Frequency Interpretation of Probability. However, such a limit only occurs in the far distant long run as the number of observations from Time Series data approached infinity. It is impossible to apply this in the short run because the long run limit, if it exists, is compatible with an infinite number of different answers. Nicholas Rescher demonstrated the nature of this fallacy a number of times in the mid-1970’s to early 1980’s. Standard Frequentist Hypothesis Testing using p-values (R. Fisher) and critical values (Neyman-Pearson) can never led to the acceptance of any hypothesis as true or correct. The only outcomes possible are to Reject the Null Hypothesis at some level of significance or to Do Not Reject the Null Hypothesis at some level of significance. Do Not Reject can never be interpreted as being Accepted, so that the hypothesis is regarded as being True, Right, or Correct. Every application of the Rational Expectations Hypothesis in all academic journal articles is inherently flawed because of the explicit claim that the long run limit can be known in a short period of time. The claim that the long run limit value can be known in the short run by a decision maker is the Fallacy of Conditional Apriorism (Long Runism). The rational expectations hypothesis attempts to claim that decision makers can identify in the short run what the long run limit is based on a faulty learning from experience argument, which is very similar to the same type of argument made by an opponent of the rational expectations hypothesis, Paul Davidson (see the references).Nicholas Rescher had already demonstrated that this is a fallacy. Finally, no amount of Frequentist hypotheses testing can EVER lead one to the conclusion that the rational expectations hypothesis has been accepted as true. Only deductive arguments are true or false, correct or incorrect, right or wrong. Inductive arguments are only more or less probable.

The Overlooked Importance of Benjamin Friedman’s Original, 1979 Critique of the Foundations of Rational Expectations Supplied by Lucas and Sargent: The Fallacy of Long Runism (Conditional a Priorism)

Lucas, Sargent, and all other proponents, advocates, users and supports of the Rational Expectations Hypothesis have overlooked the fact that their claim that decision makers can learn about and apply in the short run knowledge of the long run convergence properties of objective frequency probability distributions, as the number of observations in the series approaches infinity, is problematic. The argument, that they can learn, grasp and apply such long run knowledge and apply it in any short-run period of time, is called the fallacy of long runism (conditional apriorism). Nicholas Rescher demonstrated this repeatedly in work published in the mid to late 1970s. This error was originally made by Charles Sanders Pierce and Hans Reichenbach in their theoretical frequentist approaches to probability. Benjamin Friedman noticed the dependence of the Lucas–Sargent( 1979) claim, that decision-makers can come to know the long run convergence properties of the mechanism that is generating the long run series of observations, knowledge of which can only be learned in the distant, very long run as the limit is approached as the number of observations approaches infinity, about the applicability of the rational expectations hypothesis. Lucas-Sargent sidestepped this criticism by claiming that they could use the Bayesian, Subjective theory of probability as their foundation instead. However, in the early 2000’s, Anderson, Hansen, and Sargent (2003) and Hansen and Sargent (2011) stated that they could not use the subjective theory of probability as the foundation for the Rational Expectations Hypothesis because a large number of restrictions imposed by the rational expectations hypothesis conflicted directly with the theory of subjective probability as developed by L J Savage in 1954. Anderson, Hansen, and Sargent (2003) and Hansen and Sargent (2011) reverted to the claim that the foundation of the Rational Expectations Hypothesis was objective frequentist probability theory. However, they simply repeat the original position published in 1979 by Lucas and Sargent. Benjamin Friedman’s original critique of rational expectations in 1979 is applicable again. The failure of any user, proponent or advocate of the rational expectations hypothesis to demonstrate the forecasting superiority of the rational expectation’s hypothesis over other approaches, through the use of proper scoring rules in the nearly 60 years that have passed since the publication of Muth’s original exposition of the rational expectation’s hypothesis, calls into question the claims made by Lucas and Sargent in 1979 about rational expectations. It is difficult to find a specific theory of probability upon which proponents, advocates, user, or supporters of the rational expectations hypothesis in the literature agree is to be used to support their claims. Currently, the combined use of both subjective and objective theories of probability, which often occurs many times simultaneously in the same literature, fails to recognize that there are no objective theories of probability that recognize any role for subjective probability, and no subjective theories of probability that recognize any role for objective probability. This is most clearly specified by B. de Finetti by his famous saying that “Probability(objective) does not exist.” Rational expectationists have apparently now realized that the subjective theory of probability can’t serve as a foundation for rational expectations. They originally sought to use objective frequentist probability for their foundation until challenged by B. Friedman in 1979. They have now gone back to this foundation but have failed to deal with the objections that were originally leveled in 1979.

Bayesian dynamic stochastic general equilibrium model of Kazakhstan

The article presents dynamic stochastic general equilibrium model of Kazakhstan and its parameters estimation by Bayesian methods. A feature of DSGE-approach is the use of the neo-Keynesian microeconomic foundation, which allows describing the behavior of key economic actors and taking into account the main market failures (imperfect markets and sticky prices). In addition, DSGE-models are based on the theory of rational expectations. The model is a system of 15 linearized equations for key macroeconomic indicators of the main economic sectors: households, enterprises, the National Bank, and the external sector. The model describes the economy in the short term (excluding investments in fixed assets), in the inflation targeting mode with a floating exchange rate. Parameters were evaluated by Bayesian methods. The advantage of this approach is the possibility to estimate parameters on short time series due to the use of prior information. This is important in the conditions of structural changes. Scenario calculations were performed on the estimated parameters for aggregate factor productivity shocks and aggregate demand shocks, for prices shock and for an increase in external interest rates. The results can be used for the development of monetary policy and optimization of its parameters. The results can also be used as a foundation for building applied QPM models.

Evolution of New Keynesian Economics

In this article, the developments in the New Keynesian Economics which sprang up in USA during the ‘80s will be discussed and then the properties of the Keynesian Economics in terms of their assumptions and models will be analyzed.New Keynesian Economics is based upon the Keynesian System also considers that when the economy left to itself it will settle at less-than full-equilibrium in the short-run. Even though most of the New Keynesian economists accept rational expectations hypothesis, they refuse the perfect competition conditions and perfect elasticity of prices and wages. Hence the imperfect competition and the rigidities of prices and wages will result in the Keynesian lack-of effective demand as well as coordination failure in the market. For the long run, following the Neo-Keynesian economists, they suggest that the economy will tend towards automatic natural-rate-of-unemployment (nru) equilibrium in the long-run, apart from a few New Keynesian economists who work with Hysteresis and Efficiency Wage models. New Keynesian Economics provide the consistency between the micro- and macro-analysis and seem to be more realistic and valid for the developing countries. The representatives of the New Keynesian Economics are Alan S. Blinder, N. Gregory Mankiw, John Taylor, David Romer.

Reconsidering Rational Expectations and the Aggregation of Diverse Information in Laboratory Security Markets

In a seminal work, Plott and Sunder (1988) offer support for the rational expectations hypothesis and report evidence that markets with certain features aggregate dispersed information. However, their results are based on only a few observations and our attempt to replicate the key findings of that study with an appropriately powered experiment largely fails. The resulting post study probability that market performance is better described by rational expectations than the prior information (Walrasian) model under the conditions specified by Plott and Sunder (1988) is very low. As a result of our failure to replicate, we investigate an alternate set of market features that combines aspects of the original experimental design. For these markets we do find robust evidence of information aggregation in support of the rational expectations model. In total, our results indicate that information aggregation in asset markets is fragile and should only be expected in limited circumstances.

Firms’ Expectations on the Availability of Credit Since the Financial Crisis

Using a large set of firm-level survey data from the euro area since 2009, we analyse how firms use their information to form expectations on the availability of bank finance. Our results suggest that firms update what otherwise look like adaptive expectations on the basis of the latest information in their information set. As in the previous literature, the hypothesis that expectations fulfil the (orthogonality) conditions of the rational expectations hypothesis is rejected by the data. We find evidence that this is not only due to information imperfections but also to some type of misspecification of the expectations’ model that firms are using. In addition, we find some evidence that companies that have not used bank finance recently tend to do worse at forecasting its availability next period. To test how policy announcements may affect expectations, we concentrate on the possible effects of the ECB policy announcements of summer 2012, which included among other things the announcement of the European Central Bank’s Outright Monetary Transactions Program (OMT). Using a difference-in-differences approach, we find evidence of forward-looking expectations. In particular, shortly after the OMT announcement the forecast of “informed” firms were more upbeat compared to the control group of firms. This moreover was true in both vulnerable and non-vulnerable countries, suggesting that it was the relevance of the information about the future of the banking system that most mattered for expectations at the time, more than the immediate impact of the announced policy measures. JEL Classification: C83, D22, D84

Macro Modelling at the NIESR: Its Recent History

This paper charts the evolution of mainly empirical research at the NIESR over the 1970s and 80s. As was all too evident there were very large discrete technical improvements in data handling and manipulation over this period. Less well appreciated were the effects on the economy of major supply-side shocks coming from the World economy leading to ‘Stagflation’ and, interconnected but somewhat later, in the UK, marked changes in macro policy regime. This latter was strongly influenced by the seminal papers of Lucas (1976) and Sims (1980); both highly critical of the then current practices in macroeconomics, though each having very different intellectual stances. The response in the NIESR was to engage at an early stage in these innovations; applying the mantra that an informed criticism was more efficient than an uninformed one. During this period it became a leader in the econometrics of applied macro modelling under different expectations assumptions, including the rational expectations hypothesis (REH). Throughout, it remained critical of the anti-empirical drift encouraged in the Lucas Critique, criticism borne out more recently by the financial instability of the 1990s and the crisis that followed.

An Empirical Examination of Rational Expectations Hypothesis in the Foreign Exchange Market

The Efficient Market (EMH) and Rational Expectation Hypothesis (REH) have been examined for the Canadian Dollar / US Dollar and Swiss Frank / US Dollar exchange rates using data from February 1988 to May 1999 published by the Financial Times’ Currency Forecaster. Using unit root, and restricted co-integration techniques, we find that one-month ahead forecast is rational for the Swiss Frank / US Dollar exchange rate. However, one-month-ahead Canadian Dollar forecast is not rational. The study shows that when forecasting errors are corrected for serial correlation because of moving average process, three-month-ahead forecasts become rational for both the currencies. The twelve-month-ahead forecasts are not rational for any of the currencies.

Rational Expectations Has No Foundation in Any Coherent, Existing Theory of Probability

The theory of rational expectations has no foundation in any extant theory of probability. None of the five existing theories of probability (Logical, Subjective, Classical, Propensity, and Limiting (relative) Frequency) lend any support at all to the Muthian conjecture that the subjective probability distributions are distributed about an objective, true probability distribution. This statement is incoherent and incomprehensible because in all subjective theories of probability there are no objective theories of probability, while in all objective theories of probability there are no subjective probability distributions.

A machine‐learning analysis of the rationality of aggregate stock market forecasts

AbstractWe use a machine‐learning algorithm known as boosted regression trees (BRT) to implement an orthogonality test of the rationality of aggregate stock market forecasts. The BRT algorithm endogenously selects the predictor variables used to proxy the information set of forecasters so as to maximize the predictive power for the forecast error. The BRT algorithm also accounts for a potential non‐linear dependence of the forecast error on the predictor variables and for interdependencies between the predictor variables. Our main finding is that, given our set of predictor variables, the rational expectations hypothesis (REH) cannot be rejected for short‐term forecasts and that there is evidence against the REH for longer term forecasts. Results for three different groups of forecasters corroborate our main finding.

Do markets learn to rationally expect US interest rates? An anchoring approach

ABSTRACTWe propose an augmented and dynamic forecast anchoring model to examine whether a group of rational forecasters coexists with or emerges besides a group of forecasters employing heuristic rules. This model is consistent with the economically rational expectations theory. Using experts’ 3-month and 10-year Treasury bill rate survey expectations at short and long horizons, we find that aggregate expectations fail to exhibit a learning process towards rationality. While forecasters essentially anchor their judgements to heuristics, a small proportion of agents rationally forecast the short-term interest rate, possibly due to Federal Reserve’s transparency practice in the conduct of monetary policy and forward guidance at the zero lower bound.

LEARNING AND THE SIZE OF THE GOVERNMENT SPENDING MULTIPLIER

This paper examines the government spending multiplier when economic agents combine adaptive learning and knowledge about future fiscal policy to form their expectations. The analysis shows that the effects of a government spending shock substantially change when the rational expectations hypothesis is replaced by this learning mechanism. In contrast to the dynamics under rational expectations, a government spending shock in a small-scale new Keynesian DSGE model with learning crowdsinprivate consumption and is associated with a positive comovement between real wages and hours worked. In the baseline calibration, the output multiplier under learning is above one and about twice as large as under rational expectations.

Asset Pricing and Asymmetric Information

This study applies Johansen-Fisher panel cointegration to a sample of the most liquid shares on the Brazilian stock market for 20 years. It finds that stock prices are determined by the asymmetric information of a lagged period, and the dilution of information corrects stock prices in the current period. This shows that rational expectations theory can offer a new price measure in the rational valuation formula, and its main assumptions are met. Uninformed traders can benefit from this paper´s findings by monitoring asymmetric information.

HETEROGENEOUS EXPECTATIONS AND ENDOGENOUS FLUCTUATIONS IN THE FINANCIAL ACCELERATOR FRAMEWORK

This paper proposes a financial accelerator framework to study the effects of heterogeneous and bounded rational expectations on macroeconomic dynamics. The paper examines the fluctuations effects departing from the rational expectations hypothesis in order to understand if there are significant implications on macroeconomic volatility and policy prescriptions. The findings suggest that macroeconomic stability and inflation dynamics depend on the chosen set of forecasting rules, as well as on the monetary policy adopted. The model shows that no monetary policy is able to quickly stabilize the system, as some fluctuations persist. Central banks face a trade-off between macro-volatility and speed of convergence to the steady state. This result offers some ground for fiscal policies aiming to prompt system stability. In addition, the analysis reveals a counterintuitive result confirming the “less-is-more” effect: increasing the decision-making and computational abilities of the agents may not lead the system to converge to the preferable steady state.

New Experimental Evidence on Expectations Formation

In this paper, we measure belief formation in an experimental setting where agents are incentivized to provide accurate forecasts of a random variable, drawn from a stable and simple statistical process. Using these data, we estimate an empirical model that builds on the recent literature on expectation dynamics: It nests rational expectations, but also allows for extrapolation and under-reaction. Our findings are threefold. First, the rational expectation hypothesis is strongly rejected in our setting. Second, both extrapolation and underreaction patterns are statistically discernible in the data, but extrapolation quantitatively dominates. Third, our model coefficients are very robust to changes in experimental setting: They do not depend on process parameters, individual characteristics or framing. These large and stable deviations from rationality occur even though the forecasting exercise is simple and transparent.

A Frequency-Domain Approach to Dynamic Macroeconomic Models

This article is concerned with frequency-domain analysis of dynamic linear models under the hypothesis of rational expectations. We develop a unified framework for conveniently solving and estimating these models. Unlike existing strategies, our starting point is to obtain the model solution entirely in the frequency domain. This solution method is applicable to a wide class of models and permits straightforward construction of the spectral density for performing likelihood-based inference. To cope with potential model uncertainty, we also generalize the well-known spectral decomposition of the Gaussian likelihood function to a composite version implied by several competing models. Taken together, these techniques yield fresh insights into the model’s theoretical and empirical implications beyond what conventional time-domain approaches can offer. We illustrate the proposed framework using a prototypical new Keynesian model with fiscal details and two distinct monetary-fiscal policy regimes. The model is simple enough to deliver an analytical solution that makes the policy effects transparent under each regime, yet still able to shed light on the empirical interactions between U.S. monetary and fiscal policies along different frequencies.

On the Immense and Severe Confusions and Muddles About the Nature Ofsubjective and Objective Probability in the Theory of Rational Expectations: Asubjective Probability (Distribution) Can Never Become an Objective Probability(distribution) or a True or a Correct Probability

On the Immense and Severe Confusions and Muddles About the Nature Ofsubjective and Objective Probability in the Theory of Rational Expectations: Asubjective Probability (Distribution) Can Never Become an Objective Probability(distribution) or a True or a Correct Probability

Heterogeneous Agent Models in Financial Markets: A Nonlinear Dynamics Approach

Studies on financial markets have accumulated consistent evidences of stylized facts and anomalies, which can be characterized by stochastic switching among different co-existing market states but yet difficult to reconcile with traditionally rational expectation theory. When agents are heterogeneous and boundedly rational, recent developments on the role of the adaptive behavior of interacting heterogeneous agents in financial markets have provided a nonlinear dynamics channel to such co-existence of different market states, shedding light into these stylized facts and anomalies. This survey focuses on the nonlinear dynamics approach to model the feedback of evolutionary dynamics of heterogeneous agents and to characterize the underlying mechanisms of the stylized facts and anomalies in financial markets, of which the authors and several coauthors have contributed in several papers.

What is the true meaning behind the stochastic hypothesis which assert that E(ε)=0 ?

The aim of this Paper is to examine the meaning about the classical hypothesis which claim that the error of expectation equal zero, by mentioning all theories of expectations before and after the REH. The rational expectations paradigm has dominated the field of economics ever since it was introduced some fifty years ago. Recently research in heterogeneous expectations, bounded rationality, and models of learning have gained leverage, and focus has shifted away from the rational expectations hypothesis. Despite these developments over the past few decades, the rational expectations paradigm is still very much the standard way of handling uncertainty in economic theory, and often the rationality assumption is not seriously questioned.