Rational Expectations Hypothesis Research Articles

INTEREST RATE PREDICTABILITY IN SOME SELECTED AFRICAN COUNTRIES

This study tries to verify the predictive power of the implicit forward rate of the term structure of interest rates in Africa. We used data from Egypt, Ghana, Kenya, Nigeria and the Republic of South Africa. A modified version of the yield term premium and the forward term premium models of Shiller and McCulloch (1990) were used to test the predictive power of the implicit forward rate, rather than the rational expectations hypothesis. We both used FMOLS and DOLS estimators, since they are more consistent than OLS with non-stationary series. The overall results show that the implicit forward rate does not have a significant predictive power in Africa. It therefore appears that operators on African markets should not rely on those predictions.

Does Time Varying Risk Premia Exist in the International Bond Market? An Empirical Evidence from Australian and French Bond Market

The presence of risk premium is an issue that weakens the rational expectation hypothesis. This paper investigates changing behavior of time varying risk premium for holding 10 year maturity bond using a bivariate VARMA-DBEKK-AGARCH-M model. The model allows for asymmetric risk premia, causality and co-volatility spillovers jointly in the global bond markets. Empirical results show significant asymmetric partial co-volatility spillovers and risk premium exist in the bond markets. The estimates of the bivariate risk premia show bi-directional causality exist between the Australia and France Bond markets. Overall results suggest nonexistence of pure rational expectation theory in the risk premium model. This information is useful for the agents’ strategic policy decision making in global bond markets.

Stochastic representation decision theory: How probabilities and values are entangled dual characteristics in cognitive processes.

Humans are notoriously bad at understanding probabilities, exhibiting a host of biases and distortions that are context dependent. This has serious consequences on how we assess risks and make decisions. Several theories have been developed to replace the normative rational expectation theory at the foundation of economics. These approaches essentially assume that (subjective) probabilities weight multiplicatively the utilities of the alternatives offered to the decision maker, although evidence suggest that probability weights and utilities are often not separable in the mind of the decision maker. In this context, we introduce a simple and efficient framework on how to describe the inherently probabilistic human decision-making process, based on a representation of the deliberation activity leading to a choice through stochastic processes, the simplest of which is a random walk. Our model leads naturally to the hypothesis that probabilities and utilities are entangled dual characteristics of the real human decision making process. It predicts the famous fourfold pattern of risk preferences. Through the analysis of choice probabilities, it is possible to identify two previously postulated features of prospect theory: the inverse S-shaped subjective probability as a function of the objective probability and risk-seeking behavior in the loss domain. It also predicts observed violations of stochastic dominance, while it does not when the dominance is "evident". Extending the model to account for human finite deliberation time and the effect of time pressure on choice, it provides other sound predictions: inverse relation between choice probability and response time, preference reversal with time pressure, and an inverse double-S-shaped probability weighting function. Our theory, which offers many more predictions for future tests, has strong implications for psychology, economics and artificial intelligence.

Neoliberalismen som dominerende makroøkonomisk diskurs

This paper demonstrates that mainstream General Equilibrium Models (GEM) are dominated by neoliberal ideology. These mathematical models are pre-designed to always converging full-employment equilibrium and private-sector equilibrium. The behavioural equations are derived from the assumption of individual utility and profit maximization and the rational expectation (full foresight) hypothesis. Accordingly, policy recommendations consistent with GEM are neoliberal as they advocate (1) avoiding demand management; (2) balancing the public sector’s (structural) budget; and (3) leaving monetary policy to an independent central bank with responsibility for price stability; while (4) distributional and environmental consequences for production are considered irrelevant. This is illustrated by examples from the Danish macroeconomic environment where GEM (ADAM and DREAM) employed by the Treasury and the Council of Economic Advisors are dominant when it comes to medium and long-term policy recommendations. Finally, the article challenges this logic and objective foundation of mainstream macroeconomics.

Deviating from full rationality but not from theoretical consistency: The behavior of inflation expectations in Brazil

The aim of this paper is to investigate whether inflation expectations in Brazil have characteristics and statistical properties that can be correlated (possibly in a causal way) with observed variables of interest and expectations about them. Our analysis covers the period from December 2001 to August 2018. We test the hypothesis of rational expectations in the formation of inflation expectations by the respondents of the official survey conducted by the Central Bank of Brazil, examining the behavior of their forecast errors. As these errors are biased and can be predicted, we reject the hypothesis of full rationality. We also test models of noisy and sticky information, and we cannot conclude that the deviations from full rationality can be explained by information rigidity. Additionally, with a vector error correction model, we find evidence that the expectations about the related macroeconomic variables respond to each other as predicted by a theoretically-grounded macroeconomic model. Therefore, inflation expectations in Brazil are to an important extent consistent with more general expectations about the future performance of the economy.

Utilidade e Racionalidade na Economia Neoclássica

A teoria da utilidade é o fundamento do marginalismo que serve de base à teoria neoclássica. Desde suas origens, na década de 1870, ela passou por diversas transformações: um início hedonista (Jevons), adquiriu contornos ordinalistas (Pareto) que foram radicalizados em meados do século XX, viu a retomada da cardinalidade (von Neumann e Morgenstern), a formulação da teoria da utilidade esperada (Savage) e da hipótese das expectativas racionais. Nesse desenvolvimento histórico, a utilidade e a noção de racionalidade a ela associada foram esvaziadas de qualquer conteúdo psicológico, tornaram-se indissociáveis de cálculos probabilísticos e voltaram-se para o futuro, mas se mantiveram sempre como a pedra fundamental da teoria neoclássica. Essa última, como não poderia deixar de ser, alterou-se profundamente em consonância a essas transformações em seu conceito de base. A interpretação proposta está baseada no arcabouço conceitual de Gilles-Gaston Granger.

Learning and the Effectiveness of Central Bank Forward Guidance

AbstractThis paper examines the link between expectations formation and the effectiveness of central bank forward guidance. A standard New Keynesian model is extended to include forward guidance shocks in the monetary policy rule. Agents form expectations about future macro‐economic variables via either the standard rational expectations hypothesis or an adaptive learning model. The results show that the assumption of rational expectations overstates the effects of forward guidance relative to adaptive learning during an economic crisis. Thus, if monetary policy is based on a model with rational expectations, the results of forward guidance could be potentially misleading.

A Version of a Dynamic Stochastic General Equilibrium Model for an Open Economy

The paper presents a dynamical stochastic general equilibrium (DSGE) model for key indicators of the Russian economy. A special feature of the approach is the Keynesian microeconomic foundation, which takes into account market failures such as imperfect competition, as well as inflexible prices and wages. The second specific feature is the hypothesis of rational expectations. The model consists of a system of 17 equations describing the dynamics of key macroeconomic indicators such as GDP, inflation, interest rates, exchange rate, exports, imports, and consumption relative to its equilibrium trajectories. The model is designed to assess the nature of the reaction of key economic indicators to fluctuations in exogenous factors. Using the constructed model, the effects on key macroeconomic indicators from demand shocks, total factor productivity, and changes in the world’s interest rates are estimated. The results of modeling and calculations can be used by monetary authorities to develop monetary policy.

Learning to deal with repeated shocks under strategic complementarity: An experiment

Experimental evidence shows that the rational expectations hypothesis fails to characterize the path to equilibrium after an exogenous shock when actions are strategic complements. Under identical shocks, however, repetition allows adaptive learning, so that inertia in adjustment should fade away with experience. If this finding proves to be robust, inertia in adjustment may be irrelevant among experienced agents. The conjecture in the literature is that inertia would still persist, perhaps indefinitely, in the presence of real-world complications such as nonidentical shocks. Herein, we empirically test the conjecture that the inertia in adjustment is more persistent if the shocks are nonidentical. For both identical and nonidentical shocks, we find persistent inertia and similar patterns of adjustment that can be explained by backward-looking expectation rules. Notably, refining these rules with similarity-based learning approach improves their predictive power.

George Box’s Realization, That All Models, Especially Statistical Models, Are Wrong Means That It Is Impossible for There to Be Any True Probabilities, True Models, True Theories, True Expectations or True (Accepted) Hypotheses: The Claims, Made By Rational Expectations Proponents About True Objective Probabilities, True Models, True Expectations, True Expected Values, etc., Have No Scientific Foundation

R. Muth’s 1961 paper in Econometrica is an example of an academic economist suffering from extreme and extraordinary ignorance about very basic scientific, statistical, methodological, epistemological, philosophical, and logical tenets. These tenets were all discussed rigorously by Haavelmo in his 1944 paper in Econometrica on methodological and epistemological issues related to the question about exactly what conclusions a statistical model using economic data could support as far as sound(never valid, right ,correct, true). Haavelmo’s entire 115 page article can be summarized briefly by George Box’s brief statement noted above .Muth’s belief ,that economists had derived true theories and true models is simple nonsense. What Muth should have argued in his 1961 article, but did not, is that rational expectations, when compared to its rivals,was a better model compared to the rival models in terms of minimizing its forecasting error.Of course, Muth would have had to have supported this claim of forecast superiority with explicit proper scoring rule studies showing that the rational expectations statistical model did in fact yield superior forecast results. No such study exists at the present time because no proponent of the rational expectations hypothesis has ever demonstrated such forecasting superiority. Two additional, very severe problems result from Muth’s confused understanding of what scientific modeling is capable of regarding the specification of objective and subjective probabilities or probability distributions. First,It is simply impossible to assume the truth of the objective theory of a limiting frequency interpretation of probability and then claim that decision makers can learn from experience what the convergence properties of such a distribution are in the short run when such properties will only manifest themselves in the far ,distant(infinite)long run. It is impossible for any human ,unless rational expectations proponents are claiming that there are actual decision makers who live to infinity,to learn of such properties .Kolmogorov made it quite clear that the strengthened limiting frequency interpretation he had provided for R.Von Mises law of large numbers,which resulted from the substitution of the assumption of countable additivity for finite additivity “ …does not contribute anything to substantiate the application of the results of probability theory to real practical problems where we always have to deal with a finite number of trials”(Kolmogorov). Second, given L. J. Savage’s clearly expressed and emphasized restrictions concerning the applicability of the theory of subjective probability and expected subjective utility to the short run at the micro level ,any attempt to apply Savage’s theory at the macro level or to the intermediate to long run or intertemporally over infinite time is “utterly preposterous” and complete”nonsense according to Savage.This means that Muth’s claim about subjective probability transforming itself into objective probability might only be considered a subject for possible study and scrutiny in the short run at the microeconomic level. Economists and econometricians are good number crunchers only. Their subjective claims and beliefs about infinitely lived decision makers, who are able to learn about so called true ,objective probability distributions ,are “utterly preposterous “ and anti scientific. William McChesney Martin ,FRS chair of the BOD in Washington,D.C.from 1950 and 1970 ,correctly kept the econometricians ,economists, and Paul Volcker in the basement of the NY Federal Reserve Bank, where they had no input or say in actual or proposed monetary policy decisions. Martin realized that the extremely narrow understanding of what was required in the real world of monetary policy on the part of economists necessitated this setup. Alan Greenspan, in his 2004 (May) paper in the AER ,also rejected the applicability of the theory of rational expectations in monetary policy from 1987 to 2005,given his emphasis on the importance of taking into consideration all models, including those dealing with uncertainty where the knowledge base ranged from complete ignorance to complete knowledge. On the other hand ,A. Burns, P.Volcker,B. Bernanke, and T .Geithner did believe that their mathematical and econometric models were true. One can compare the great success of Martin and Greenspan with the failures of Volcker and Bernanke(Geithner) and reach the conclusion that it is time to return the economists and econometricians back to the basement of the FRBNY where they belong as effective and useful number crunchers only.

Voluntary overbooking in commercial airline reservations

This paper studies a voluntary overbooking model under rational expectation equilibrium to promote cooperation between customers and airlines, maintain goodwill of customers, and maximize the expected total returns to airlines. A decision tree analysis is constructed for both customers and airlines. Sensitivity analysis is conducted in both realistic and simulated no-show random variables for validation. The findings suggest considerable mutual benefits associated with a ‘voluntary overbooking’ policy that emphasizes mutual cooperation between passengers and commercial airlines. The main underlying assumption of the paper is that customers are willing to provide valuations to airlines seeking volunteers for overbooking. The originality of the proposed model is the incorporation of elements of the Rational expectations hypothesis into classical overbooking models gleaned from the literature.

Tests for nonlinear restrictions under misspecified alternatives with an application to testing rational expectation hypotheses

SummaryThis paper develops generalized method of moments-based (GMM-based) Lagrange multiplier tests for nonlinear hypotheses that are robust to locally misspecified possibly nonlinear alternatives. The procedure is based on an initial consistent GMM estimator of the parameters under a given set of nonlinear restrictions. The new test for one particular set of nonlinear hypotheses is consistent and has correct asymptotic size independently of whether the other, also nonlinear hypotheses, are correct or locally misspecified. To illustrate the usefulness of our proposed tests we consider testing rational expectations hypotheses using U.S. data.

THE PRICE MECHANISM FUNCTION OF CURLY RED CHILLY IN THE CENTER OF PRODUCTION AND WHOLESALER

The problem of red chili related to price fluctuations has always been a concern for farmers.Therefore, an increase in the production of agricultural commodities including chili horticultural commodities needs to be accompanied by improvements to the marketing system. These research was quantitative research, data collection was done by means of a survey of time series . The data used are time series data and supporting data which come from: Information center of price at production center, and price information at West Java Food Crop Agriculture Agency. From the amount of data (included observation) which amounted to 72 data. The technic analyzed used multivariate. ,the rational expectation hypothesis of the supply function was analyzed by the EVIEWS 8. the results of price analysis in Cikajang have a dominant influence on prices in the PIKJ and vice versa, the results of the analysis show that an increase in price of 1 rupiah in Cikajang will increase the price in PIKJ 0.7679 rupiah, or an increase in price of 76.79% meaning an increase in prices in production centers will raised the price of 76.79% in the PIKJ. PIKJ will quickly respond to price increases in production centers even though the distance from production centers to PIKJ was very far, the flow of price information that occurs was actually one-way from PIKJ to production centers. The response to the high price increase was seen that the PIKJ was a price determinant and when viewed from the marketing actors involved in it turns out there were farmers in the production center which were dealers or traders in the PIKJ.

Stochastic representation decision theory: How probabilities and values are entangled dual characteristics in cognitive processes

Humans are notoriously bad at understanding probabilities, exhibiting a host of biases and distortions that are context dependent. This has serious consequences on how we assess risks and make decisions. Several theories have been developed to replace the normative rational expectation theory at the foundation of economics. These approaches essentially assume that (subjective) probabilities weight multiplicatively the utilities of the alternatives offered to the decision maker, although evidence suggest that probability weights and utilities are often not separable in the mind of the decision maker. In this context, we introduce a simple and efficient framework on how to describe the inherently probabilistic human decision-making process, based on a representation of the deliberation activity leading to a choice through stochastic processes, the simplest of which is a random walk. Our model leads naturally to the hypothesis that probabilities and utilities are entangled dual characteristics of the real human decision making process. It predicts the famous fourfold pattern of risk preferences. Through the analysis of choice probabilities, it is possible to identify two previously postulated features of prospect theory: the inverse S-shaped subjective probability as a function of the objective probability and risk-seeking behavior in the loss domain. It also predicts observed violations of stochastic dominance, while it does not when the dominance is evident. Extending the model to account for human finite deliberation time and the effect of time pressure on choice, it provides other sound predictions: inverse relation between choice probability and response time, preference reversal with time pressure, and an inverse double-S-shaped probability weighting function. Our theory, which offers many more predictions for future tests, has strong implications for psychology, economics and artificial intelligence.

What were they thinking? Firms' expectations since the financial crisis

PurposeThis paper explores how firms formed their expectations about the availability of bank finance since the financial crisis. Various expectations hypotheses that incorporate backward and/or forward-looking elements and inattention are tested. From a policy perspective, the most important hypothesis is whether policy announcements have a direct impact on the expectations of companies.Design/methodology/approachThe analysis is based on a large sample of euro area companies from the ECB “Survey on the Access to Finance of Enterprises” between 2009 and 2018. Ordered logit models are used to relate individual replies on expectations to firms' information available at the time of the forecasts. The model controls for the business cycle and firms' structural characteristics. Using a difference-in-differences approach, we test how policy announcements may affect expectations.FindingsFirms update what otherwise look like adaptive expectations on the basis of new information. The hypothesis of rational expectations is rejected. Moreover, we do not find evidence of inattention or of a wave of pessimism/optimism. The analysis of expectations around the time of the ECB Outright Monetary Transactions program provides some evidence of forward-looking expectations.Originality/valueThe paper contributes to the literature on expectations by using a novel survey in eleven countries. In the multi-country setting, country-specific business cycle effects and waves of pessimism or optimism are better controlled for. The policy announcements of summer 2012 provide for a natural experiment to test the direct impact of such announcements on expectations, an issue of relevance for the monetary policy transmission to economic activity.

Behavioral economics and DSGE-modeling

The article considers the “behavioral” modification of the standard DSGE model proposed by X. Gabaix. In his model, agents behave in a boundedly rational manner, showing incomplete attention to macroeconomic statistics. Moreover, unlike other attempts to abandon the hypothesis of rational expectations in favor of a model of adaptive and/or static expectations, the Gabaix model is initially constructed taking into account the inattention of economic agents to macro variables. The consequence of bounded rationality is that monetary policy is less effective (compared to the model of rational expectations) and, conversely, fiscal policy is effective due to the fact that Ricardo equivalence is not fulfilled. If the inertia of inflation expectations is taken into account in the Gabaix model, it demonstrates that the interest rate has a positive effect on inflation in the long run. Bayesian estimates for the rationality coefficient in the Russian economy are presented. Moreover, attention to inflation is much lower than attention to the variable of economic activity.

Learning to Deal With Repeated Shocks Under Strategic Complementarity: An Experiment

Experimental evidence shows that the rational expectations hypothesis fails to characterize the path to equilibrium after an exogenous shock when actions are strategic complements. Under identical shocks, however, repetition allows adaptive learning, so that inertia in adjustment should fade away with experience. If this finding proves to be robust, inertia in adjustment may be irrelevant among experienced agents. The conjecture in the literature is that inertia would still persist, perhaps indefinitely, in the presence of real-world complications such as nonidentical shocks. Herein, we empirically test the conjecture that the inertia in adjustment is more persistent if the shocks are nonidentical. For both identical and nonidentical shocks, we find persistent inertia and similar patterns of adjustment that can be explained by backward-looking expectation rules. A reformulation of naive expectations with similarity-based learning approach is found to have a higher predictive power than rational and trend-following rules.

Rationality of Insurance Firms' Forecasts : Results of Unbiasedness and Efficiency Tests

Many applied studies have tried to test the implications of rational expectations hypothesis on survey data. This study provides evidence on the rationality of economic forecasts made by insurance firms in a developing economy-Malaysia. Our unbiasedness test results suggest that anticipated gross revenue and employment are unbiased predictors of actual gross revenue and employment respectively. Furthermore, our efficiency tests results indicate that insurance firms utilized relevant information efficiently at the time the forecasts were made.

Quantifying Qualitative Survey Data: New Insights on the (Ir)Rationality of Firms' Forecasts

Using a novel dataset that contains qualitative firm survey data on sales forecasts as well as balance-sheet data on realized sales, we document that only major forecast errors are predictable and display autocorrelation. This result is a particular violation of the Full Information Rational Expectations hypothesis that requires explanation. In contrast, minor forecast errors are neither predictable nor autocorrelated. To arrive at this result, we develop a novel methodology to quantify qualitative survey data on firm forecasts. It is generally applicable when quantitative information, e.g. from balance sheets, is available on the realization of the forecasted variable. Finally, we provide a model of rational inattention that explains our empirical results. Firms optimally limit their degree of attention to information when operating in market environments where information processing is more costly. This results in major forecast errors that are predictable and autocorrelated.

Learning to Deal With Repeated Shocks Under Strategic Complementarity: An Experiment

Experimental evidence shows that the rational expectations hypothesis fails to characterize the path to equilibrium after an exogenous shock when actions are strategic complements. Under identical shocks, however, repetition allows adaptive learning, so that inertia in adjustment should fade away with experience. If this finding proves to be robust, inertia in adjustment may be irrelevant among experienced agents. The conjecture in the literature is that inertia would still persist, perhaps indefinitely, in the presence of real-world complications such as nonidentical shocks. Herein, we empirically test the conjecture that the inertia in adjustment is more persistent if the shocks are nonidentical. For both identical and nonidentical shocks, we find persistent inertia and similar patterns of adjustment that can be explained by backward-looking expectation rules. A reformulation of naive expectations with similarity-based learning approach is found to have a higher predictive power than rational and trend-following rules.