Overreaction and Diagnostic Expectations in Macroeconomics

optimally rational expectations and macroeconomics

This paper provides an alternative to the theory of rational expectations (RE). Its central idea is that the information set on which agents will choose to condition their expectations will not, in general, include all the available information. Our alternative has many of the attractive features of RE; it emerges from an explicit choice-theoretic framework; it has wide applicability; and it ca...

Expectations in Macroeconomics: Adaptive versus Eductive Learning1

Rational expectations solutions to macroeconomic models are equilibria requiring the coordination of expectations, and one can investigate the local stability of these solutions under alternative learning rules. Eductive (mental) approaches to learning have somewhat stricter stability conditions than do adaptive (statistical) approaches, as we illustrate using three economic models. The expecta...

SERIE RESEARCH mEmORMIDII RATIONAL EXPECTATIONS AND NEW CLASSICAL MACROECONOMICS

Stock Market Overreaction to Bad News in Good Times: A Rational Expectations Equilibrium Model

This article presents a dynamic, rational expectations equilibrium model of asset prices where the drift of fundamentals (dividends) shifts between two unobservable states at random times. I show that in equilibrium, investors’ willingness to hedge against changes in their own “uncertainty” on the true state makes stock prices overreact to bad news in good times and underreact to good news in b...

The Contingent Expectations Hypothesis : Conditional Rationality in Macroeconomics and Finance Theory