Hostname: page-component-586b7cd67f-dsjbd Total loading time: 0 Render date: 2024-11-26T15:45:45.502Z Has data issue: false hasContentIssue false
  • English
  • Français

RATIONALITY OF BELIEFS AND MODEL CONSISTENCY

Published online by Cambridge University Press:  01 March 2008

Miroslav Misina
Miroslav Misina*
Affiliation:
Bank of Canada
Get access Rights & Permissions [Opens in a new window]

Abstract

The assumption of rational expectations (RE) plays two roles in economic models: it imposes restrictions on behaviour of agents, and it ensures model consistency. Dissatisfaction with RE on behavioural grounds has, in a variety of models, led to its replacement by more behaviourally plausible postulates. However, replacing RE by ad hoc behavioural postulates may result in internally inconsistent models. This work introduces a conceptual framework within which the nature of the issue can be described, and points to potential problems that the abandonment of RE entails. We argue that the RE-based notion of consistency is model-specific rather than general, and introduce a weaker consistency condition that is relevant for non-RE models. To assess the consistency of these models, we propose a test and illustrate its use taking an example from the recent literature. Broader implications of the findings are discussed.

Type
Essay
Information
Economics & Philosophy , Volume 24 , Issue 1 , March 2008 , pp. 65 - 79
Copyright
Copyright © Cambridge University Press 2008

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

REFERENCES

Cecchetti, S., Lam, P., and Mark, N.. 2000. Asset pricing with distorted beliefs: are equity returns too good to be true? American Economic Review 90: 787–805.CrossRefGoogle Scholar
Gilovich, T., Griffin, D., and Kahneman, D., eds. 2002. Heuristics and biases: The psychology of intuitive judgement. Cambridge University Press.CrossRefGoogle Scholar
Hirshleifer, D. 2001. Investor psychology and asset pricing. Journal of Finance 61: 1533–97.Google Scholar
Kahneman, D., Slovic, P. and Tversky, A., eds. 1982. Judgment under uncertainty: Heuristics and biases. Cambridge University Press.Google Scholar
Kahneman, D. and Tversky, A., eds. 2000. Choices, values, and frames. Cambridge University Press.CrossRefGoogle Scholar
Kocherlakota, N. 1996. Equity premium: it's still a puzzle. Journal of Economic Literature 34: 42–71.Google Scholar
Kurz, M. 1994. On the structure and diversity of rational beliefs. Economic Theory 4: 877–900.CrossRefGoogle Scholar
Kurz, M. 1997. Endogenous economic fluctuations: Studies in the theory of rational beliefs. Springer-Verlag.Google Scholar
Lucas, R. 1978. Asset prices in and exchange economy. Econometrica 66: 1429–45.CrossRefGoogle Scholar
Mehra, R. and Prescott, E. 1985. Equity premium: a puzzle. Journal of Monetary Economics 15: 145–62.Google Scholar
Miller, R, ed. 1996. The rational expectations revolution: Readings from the front line. MIT Press.Google Scholar
Misina, M. 2003. Are distorted beliefs too good to be true? Bank of Canada working paper 2003-4.Google Scholar
Misina, M. 2006. Equity premium with distorted beliefs: a puzzle. Journal of Economic Dynamics and Control 30: 1431–40.CrossRefGoogle Scholar
Muth, J. 1961. Rational expectations and the theory of price movements. Econometrica 29: 315–35.CrossRefGoogle Scholar
Ore, O. 1952. On the selection of subsequences. Proceedings of the American Mathematical Society 3: 706–712.CrossRefGoogle Scholar
Radner, R. 1972. Existence of equilibrium of plans, prices, and price expectations in a sequence markets. Econometrica 40: 289–304.Google Scholar
Sheffrin, S. 1996. Rational expectations. Cambridge University Press.CrossRefGoogle Scholar
Shleifer, A. 2000. Inefficient markets: an introduction to behavioural finance. Oxford University Press.Google Scholar