Review of Behavioral Economics > Vol 1 > Issue 1–2

Behaviorally Rational Expectations and Almost Self-Fulfilling Equilibria

Cars H. Hommes, CeNDEF, University of Amsterdam and Tinbergen Institute, The Netherlands, C.H.Hommes@uva.nl
 
Suggested Citation
Cars H. Hommes (2014), "Behaviorally Rational Expectations and Almost Self-Fulfilling Equilibria", Review of Behavioral Economics: Vol. 1: No. 1–2, pp 75-97. http://dx.doi.org/10.1561/105.00000004

Published: 15 Jan 2014
© 2014 C. H. Hommes
 
Subjects
 
Keywords
D84D83E32C92
Expectation feedbackSelf-fulfilling beliefsHeuristic switching modelExperimental economicsMacroeconomics
 

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In this article:
1. Introduction
2. A New Keynesian Philips Curve
3. A Behavioral Asset Pricing Model
4. Laboratory Experiments
5. Conclusions
References

Abstract

Rational expectations assume perfect, model consistency between beliefs and market realizations. Here we discuss behaviorally rational expectations, characterized by an observable, parsimonious, and intuitive form of consistency between beliefs and realizations. We discuss three case-studies. Firstly, a New Keynesian macro model with a representative agent learning an optimal, but misspecified, AR(1) rule to forecast inflation consistent with observed sample mean and first-order autocorrelations. Secondly, an asset pricing model with heterogeneous expectations and agents switching between a mean-reverting fundamental rule and a trend-following rule, based upon their past performance. The third example concerns learning-to-forecast laboratory experiments, where under positive feedback individuals coordinate expectations on non-rational, almost self-fulfilling equilibria with persistent price fluctuations very different from rational equilibria.

DOI:10.1561/105.00000004