Modeling Expectation Formation Involving Several Sources of Information

Abstract. Experimental studies of expectation formation of subjects are predominantly limited to the prediction of one single time series despite the practical relevance of expectations in situations with multiple sources of information. In this paper, we report on an experiment in which subjects are given time series (indicators) as additional information for the judgemental forecast of a stationary time series. The quality and the number of these indicators are varied in three versions of a forecasting experiment. We explore the effects on forecasting accuracy and we test the average forecasts of the subjects for consistency with the rational expectations hypothesis. A simple heuristic is presented that explains the average forecasting behavior better than the rational expectations if indicators are presented to the subjects. It is demonstrated by a simulation study that this result is representative for the considered stationary stochastic processes.     

Inflationary expectations with heterogeneous information: ‘generational expectations’

This paper proposes a modified theory of expectation formation. The hypothesis of generational expectations (GE), unlike the widely accepted hypothesis of rational expectations, assumes that agents from their inflationary expectations using the most economical information set – their personal experience with inflation. The GE hypothesis incorporates the realistic assumptions of heterogenous information sets and bounded rationality. Several alternative expectational hypotheses are compared in terms of properties of inflation forecasts and estimates of a version of natural-rate aggregate supply functions and age-group-specific Phillips curves. It is shown that GE performs just as well or even better than other methods.     

Rational expectation bubbles: evidence from Hong Kong’s sub-indices

This article uses Hong Kong stock market’s four sub-indices to examine the existence and causes of rational expectation bubbles. The unit root test is applied to the rational bubble hypothesis. Various causality test methods are used to examine the causality of bubble among the four sub-indices. The empirical results show that in the sub-periods of 1986 to 2002 and 2000 to 2012, the bubbles of commerce and industry and utilities industries are consistent with rational expectation bubbles, but not so in the finance and properties industries. In general, the rational expectation bubbles in the two sub-periods seemed to have been caused by expectations in other growing foreign economies.     

Comparing behavioural and rational expectations for the US post-war economy

The banking crisis has caused a resurgence of interest in behavioural models of expectations in macroeconomics. Here we evaluate behavioural and rational expectations econometrically in a New Keynesian framework, using US post-war data and the method of indirect inference. We find that after full reestimation the model with behavioural expectations is strongly rejected by the data, whereas the standard rational expectation version passes the tests by a substantial margin.     

A heterogeneous agent exchange rate model with speculators and non-speculators

This paper constructs a heterogeneous agent exchange rate model of speculators and non-speculators from a simple monetary framework. The model replaces rational expectations with an adaptive learning rule that forecasts future exchange rates with an econometric model, and assumes two types of market participants, speculators and non-speculators, that differ by their forecasting model. Speculators employ a correctly specified forecasting model, are relatively short-term oriented, and are subject to momentum and herding effects via an expectation shock; non-speculators utilize a simple forecasting model, have no incentive to be short-term oriented, and are not subject to herding effects. Parameters are calibrated and estimated using the method of simulated moments, and simulation results show that the model is able to replicate foreign exchange market stylized facts better than a model of representative agent rational expectations. Furthermore, the dynamics of the model are shown to derive from both agent heterogeneity and the expectation shock.     

Volatility spill-overs in commodity spot prices: New empirical results

The classical rational expectations model of commodity markets implies that expected spot price risk is an explanatory variable in spot price regressions; and also that inventory carryover, which is reduced by a larger price variance, creates autoregressive conditional heteroscedastic processes in spot prices. In order to falsify/verify this theory, it has typically been assumed that the square root of the conditional variance of spot prices, a proxy for spot price risk, enters the conditional mean function of spot prices. Based on this simple representation, a typical but counter intuitive outcome has been that spot price risk has an insignificant impact on spot prices, see, e.g., Beck (Beck, S., 1993. A Rational Expectations Model of Time Varying Risk Premia in Commodities Futures Markets: Theory and Evidence. International Economic Review 34, 149–168, Beck, S., 2001. Autoregressive Conditional Heteroskedasticity in Commodity Spot Prices. Journal of Applied Econometrics 16, 115–132). In this paper, we propose an alternative functional relationship (from GARCH(1,1) to GARCH(1,1)-AR(m)) between spot price risk and spot prices that is fully supported by the classical rational expectations model, and based on this new representation we are able to provide stronger empirical support for Muth's rational expectation theory.     

Targets and lags in a two-equation model of US stabilization

A simple model of activist macroeconomic policy derives a reaction function by assuming that rational governments have performance objectives, but are constrained by the Phillips curve. Although not formally modeled, governments apply a variety of instruments to influence inflation and output, in addition to monetary policy these include fiscal policy, bailouts and exchange rates. Our econometric results are generally consistent with US economic history. One qualification is that governments appear more likely to target growth rates than output gaps. Another inference is that inflation expectations are more likely to be backward than forward looking; a variety of rational expectation models fit the data less well than do simple inertial expectations. We also find that annual data series are more appropriate than quarterly ones for studying these issues.     

异质预期及其经济影响——基于货币经济学的新视角

异质预期是指不同的主体因信息不完全、不对称,或由于认知局限,或使用的预测模型不同等而形成不同的预期,它是一个与理性预期相对的新经济学范畴。除了信息、初始认知外,学习是影响异质预期形成的一个重要因素。在存在异质预期的环境中,经济结果取决于所有参与者的预期。与理性预期相比,异质预期是一种更复杂的传递机制,它会加强和放大经济内在的传导机制,孳生经济波动,增加通货膨胀持久性。预期异质性提高了货币政策的作用,我们应充分发挥货币政策的稳定功能。     

Rational expectations and M2 demand

This essay expands on existing studies of M2 money demand. It differs in that it applies a rational expectations approach to an adaptive expectation model. Unlike the adaptive expectations models, the author includes an explanatory variable for expectations of future inflation. The expectation variables used are: the actual inflation rate (t + 1) and the Livingston Survey from the Philadelphia Fed. By using the different measures of expectations the author is able to compare several adaptive expectations models that appear in the literature and the rational expectations models for fit and forecast ability. The empirical results are such that the importance of including the rational expectations variable is evident even though the overall fit of the equation is comparable to one of the existing adaptive expectations models.     

Learning process and rational expectations: An analysis using a small macro-economic model for New Zealand

The nature of expectations matters when conducting monetary policy. Models with a learning process can exhibit very different properties from models with other types of expectation rules. This paper draws on the work of Orphanides and Williams [Orphanides, A., Williams, J.C. 2002. Imperfect knowledge, inflation expectations and monetary policy, Federal Reserve Board Finance and Economics Discussion Series, 2002-27], extending it to allow for the possibility that the learning process may not be perpetual, but rather might be converging towards a rational expectations equilibrium. By modelling expectations using a learning process, we obtain that inflation expectations in New Zealand are moving towards rational expectations. The closer expectations are to rational, the more inflation can be reduced without costs, thus arguing for a rather tough policy aimed at anchoring expectations on the target.     

Direct test of the rational expectation hypothesis

In this paper we examine the possibility of testing the rational expectation hypothesis from simultaneous observations of some variables y and of their expectation y1. The test procedures are related to the sort of data available, generally obtained from tendency surveys. We distinguish between qualitative and quantitative data, we define in each case the notion of rational expectation. Then it is possible to characterize the rational expectation hypothesis and to develop adapted test procedures.     

Expectation formation in the foreign exchange market: a time-varying heterogeneity approach using survey data

Using Consensus Economics survey data on JPY/USD and GBP/USD exchange rate expectations for the 3- and 12-month horizons over the period November 1989–December 2012, we first show that expectations fail the conventional tests of unbiasedness and do not exhibit a learning process towards rationality. Our approach is consistent with the economically rational expectations theory (Feige and Pearce, 1976), which states that information costs and agents’ aversion to misestimating future exchange rates determine the optimal amounts of information on which they base their expectations. The time variability of the cost/aversion ratios justifies at the aggregate level a representation of expectations as a linear combination of the traditional extrapolative, adaptive and regressive processes augmented by a forward market component, whose parameters are allowed to change over time. This mixed expectation model with unstable heterogeneity is validated by our Kalman filter estimation results for the two currencies and the two horizons considered. Although the relative importance of the ‘fundamentalists’ (‘chartists’) is found to increase (decrease) with the time-horizon, chartist behaviour appears to dominate fundamentalist behaviour for both horizons. Central bank intervention is then effective in stabilizing the foreign exchange markets if it encourages fundamentalist activity.     

A Note on Aggregation and the Lucas Critique

The paper investigates the effects of aggregation on different macroeconomic modelling strategies. This is done within the framework of a small example economy, where all households solve the same intertemporal consumption problem, but with different parameters of the utility functions and different exogenous income processes. Three models are fitted to the aggregate data: a representative agent rational expectations model, a simple version of the permanent income hypothesis, and a time series model. If the economic environment is kept stable, the three approaches perform similarly well. However, the representative agent model stands up to the Lucas critique better than its competitors, despite the aggregation error. Unlike the other models, it never gives completely wrong forecasts even after an exogenous change in income processes.     

Separating short-term and long-term inflation expectations using observations from financial markets

The analysis of inflation expectations is extended by distinguishing between short-term and long-term expectations using data from financial markets. The term structure of inflation expectation is explicitly considered. The adaptive expectations hypothesis obtains strong support from the data, while the Frenkel hypothesis can clearly be rejected. This result is clearly at variance with those obtained in Lahiri (1981).     

The social dynamics of expectations: The interaction of collective and actor-specific expectations on electronic commerce and interactive television

The article investigates three mechanisms by which expectation dynamics affect innovation processes. Empirically, it focuses on hype-disappointment cycles in electronic commerce and interactive television, drawing on results from qualitative case studies and secondary analysis. First, two specific ways by which collective, i.e. widely shared, expectations motivate and guide innovation actors are presented. These mechanisms serve as an explanation for the fact that often an impressively large number of heterogeneous actors accept and contribute to high-rising expectations. With reference to a third mechanism, it is shown that results of technological projects are subject to interpretative flexibility and, as such, are interpreted in the light of the same expectations they are supposed to 'validate'. Sudden changes of the consideration of certain technologies as promising or not are then explained as a result of the interaction between collective expectations and expectations and outcomes at the project level.     

RATIONAL CONSUMERS*

The life cycle/permanent income hypothesis (LCPIH) entails two postulates: People have rational expectations and people do not have problems with self‐control. If either or both of these postulates do not apply, we cannot obtain a testable implication for the LCPIH. We use Japanese representative panel data that include responses to self‐reported and retrospective questions in order to elicit behavior such as forward‐looking and self‐control problems. We test the rational expectations hypothesis and the LCPIH implication and find that rational consumers do not change their expenditure in response to expected income changes, which we restrict to fit the two LCPIH postulates.     

The necessity of delaying economic adjustment

I give an explanation for why agents react with a delay to decision and expectation parameters, by showing that imperfect agents must adjust very slowly relative to optimally adjusting agents if they begin reacting as soon as the latter agents would react. The results follow from the hypothesis of imperfect choice alone irrespective of whether there are any information, search, transaction, or other costs of adjusting decisions. The results thereby provide a general reason for observing inertially lagged behavior, and also agree with recent asset market experiments whose dynamics are governed by adaptive rather than ‘rational’ expectations.     

Beyond the efficient markets hypothesis: Towards a new paradigm

To go beyond the efficient markets hypothesis (EMH) we suppose that the stock market can be in one of three states: (1) a fundamental state, where share prices are determined largely as in the EMH; (2) a bubble or bull market state, where share prices are above their fundamental levels but are expected to continue to rise further, and (3) a bear market state, where shares are held exclusively by irrational agents and rational agents cannot exploit the overvaluation because of short-selling constraints. Also, heterogeneous rational expectations may help explain some features of stock market behaviour.     

The velocity of money and the random walk hypothesis

In this note it is shown, using a simple money demand function and the assumption of rational expectations, that the velocity of money may be expected to have a more complex time series representation than that proposed by other researchers. The hypothesis is tested using quarterly U.K. data, over the period 1971 to 1982.     

我国居民通胀预期的测度:基于银行间债券市场数据的方法

通胀预期测度是通胀预期管理的前提。文章基于通货膨胀持久性特征,在无套利假设下,将实际通胀率这一宏观变量纳入传统的因子模型中,并运用银行间债券市场收益率数据对我国居民通胀预期进行了估计,结果显示我国居民通胀预期并不完全满足理性预期假设,而是与实际通胀之间存在有规律的系统性偏差,短期实际利率的变动是造成偏差的主要原因。文章认为通过强化货币政策前瞻性可以消除这种偏差,从而抑制实际通货膨胀水平。