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Rational vs. Irrational Beliefs in a Complex World

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  • Gregor Boehl
  • Cars Hommes

Abstract

Can boundedly rational agents survive competition with fully rational agents? We develop a highly nonlinear heterogeneous agents model with rational forward looking versus boundedly rational back- ward looking agents and evolving market shares depending on their relative performance. Our novel numerical solution method detects equilibrium paths characterized by complex bubble and crash dy- namics. Boundedly rational trend-extrapolators amplify small deviations from fundamentals, while rational agents anticipate market crashes after large bubbles and drive prices back close to fundamen- tal value. Overall rational and non-rational beliefs co-evolve over time, with time-varying impact, and their interaction produces complex endogenous bubble and crashes, without any exogenous shocks.

Suggested Citation

  • Gregor Boehl & Cars Hommes, 2021. "Rational vs. Irrational Beliefs in a Complex World," CRC TR 224 Discussion Paper Series crctr224_2021_287, University of Bonn and University of Mannheim, Germany.
    • Handle: RePEc:bon:boncrc:crctr224_2021_287
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    File URL: https://www.crctr224.de/research/discussion-papers/archive/dp287
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    Cited by:

    1. Boehl, Gregor, 2022. "Monetary policy and speculative asset markets," European Economic Review, Elsevier, vol. 148(C).

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    More about this item

    Keywords

    Heterogeneous agents; trend-extrapolation; bubbles; numerical solution method;
    All these keywords.

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • E03 - Macroeconomics and Monetary Economics - - General - - - Behavioral Macroeconomics
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers

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