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A Behavioral Defense of Rational Expectations

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Abstract

This paper studies decision making by agents who value optimism, but are unsure of their environment. As in Brunnermeier and Parker (2005), an agent’s optimism is assumed to be tempered by the decision costs it imposes. As in Hansen and Sargent (2008), an agent’s uncertainty about his environment leads him to formulate ‘robust’ decision rules. It is shown that when combined, these two considerations can lead agents to adhere to the Rational Expectations Hypothesis. Rather than being the outcome of the sophisticated statistical calculations of an impassive expected utility maximizer, Rational Expectations can instead be viewed as a useful approximation in environments where agents struggle to strike a balance between doubt and hope.

Suggested Citation

  • Kenneth Kasa, 2012. "A Behavioral Defense of Rational Expectations," Discussion Papers dp12-05, Department of Economics, Simon Fraser University.
    • Handle: RePEc:sfu:sfudps:dp12-05
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    File URL: http://www.sfu.ca/repec-econ/sfu/sfudps/dp12-05.pdf
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    References listed on IDEAS

    as
    1. Tomasz Strzalecki, 2011. "Axiomatic Foundations of Multiplier Preferences," Econometrica, Econometric Society, vol. 79(1), pages 47-73, January.
    2. Christopher A. Sims, 2001. "Pitfalls of a Minimax Approach to Model Uncertainty," American Economic Review, American Economic Association, vol. 91(2), pages 51-54, May.
    3. Lucas, Robert E, Jr, 1986. "Adaptive Behavior and Economic Theory," The Journal of Business, University of Chicago Press, vol. 59(4), pages 401-426, October.
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Rational expectations as an optimal approximation
      by Economic Logician in Economic Logic on 2012-04-25 19:04:00

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    Cited by:

    1. Mejía Cubillos, Javier, 2012. "Libertad y desempeño económico [Freedom and economic performance]," MPRA Paper 37939, University Library of Munich, Germany.

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    More about this item

    Keywords

    Rational expectations; robustness;

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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