Intrinsic heterogeneity in expectation formation

We introduce the concept of a Misspecification Equilibrium to dynamic macroeconomics. A Misspecification Equilibrium occurs in a stochastic process when agents forecast optimally given that they must choose from a list of misspecified econometric models. With appropriate restrictions on the asymptotic properties of the exogeneous process and on the feedback of expectations, the Misspecification Equilibrium will exhibit Intrinsic Heterogeneity. Intrinsic Heterogeneity is a Misspecification Equilibrium where all misspecified models receive positive weight in the distribution of predictors across agents. Interestingly, the existence of heterogeneity depends on the self-referential property of the model. Our derivation of heterogeneous expectations as the equilibrium outcome of a model is a departure from the previous literature which makes ad hoc assumptions about the degree of heterogeneity. JEL Classifications: C62; D83; D84; E30