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Dropping Rational Expectations

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  • Lionel de Boisdeffre

    (CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, CATT - Centre d'Analyse Théorique et de Traitement des données économiques - UPPA - Université de Pau et des Pays de l'Adour)

Abstract

We had proposed earlier a general equilibrium model with incomplete financial markets and asymmetric information, where agents forecasted prices privately without rational expectations. Consistently, they anticipated idiosyncratic sets of future prices and elected probability laws on these sets, that we called beliefs. Under mild conditions and differently from Hart [1975] and Radner [1979] equilibrium always existed in this model, as long as agents' anticipations precluded arbitrage. The joint determination of equilibrium prices and beliefs is traditionally seen as a rational expectation problem. Hereafter, we suggest it may be otherwise. We propose to show that agents, whose prior anticipation sets yield an arbitrage, may update their expectations from observing trade opportunities on financial markets. With no price to be observed, they eventually infer smaller arbitrage-free anticipation sets, which can not be narrowed down any further. Once these sets are attained, equilibrium prices may change if agents change their beliefs, but they will convey the same information.

Suggested Citation

  • Lionel de Boisdeffre, 2015. "Dropping Rational Expectations," Post-Print halshs-01164158, HAL.
    • Handle: RePEc:hal:journl:halshs-01164158
    Note: View the original document on HAL open archive server: https://shs.hal.science/halshs-01164158
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    References listed on IDEAS

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    1. Bernard Cornet & Lionel Boisdeffre, 2009. "Elimination of arbitrage states in asymmetric information models," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 38(2), pages 287-293, February.
    2. Radner, Roy, 1979. "Rational Expectations Equilibrium: Generic Existence and the Information Revealed by Prices," Econometrica, Econometric Society, vol. 47(3), pages 655-678, May.
    3. Hart, Oliver D., 1975. "On the optimality of equilibrium when the market structure is incomplete," Journal of Economic Theory, Elsevier, vol. 11(3), pages 418-443, December.
    4. Cornet, Bernard & De Boisdeffre, Lionel, 2002. "Arbitrage and price revelation with asymmetric information and incomplete markets," Journal of Mathematical Economics, Elsevier, vol. 38(4), pages 393-410, December.
    5. Bernard Cornet & Lionel Boisdeffre, 2009. "Elimination of arbitrage states in asymmetric information models," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 38(2), pages 287-293, February.
    6. Radner, Roy, 1972. "Existence of Equilibrium of Plans, Prices, and Price Expectations in a Sequence of Markets," Econometrica, Econometric Society, vol. 40(2), pages 289-303, March.
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