Author(s): Branch, William | Abstract: Previous work with survey data casts doubt on the Rational Expectations Hypothesis. In this paper, we develop a model of expectation formation where agents form their forecasts of inflation by selecting a predictor function from a set of costly alternatives whereby they may rationally choose a method other than the most accurate. We use this model to test whether survey data exhibit rationally heterogeneous expectations. Maximum likelihood is applied to a new discrete choice setting where the observed variable is continuous and the latent variable is discrete. The results show there is dynamic switching that depends on relative mean squared errors of the predictor.

/pdf/the-theory-of-rationally-heterogeneous-expectations-evidence-3gf53ykh1a.pdf

The Theory of Rationally Heterogeneous Expectations: Evidence from Survey Data on Inflation Expectations†

Publisher Summary Although there might be agreement that the standard paradigm does not fully explain what is causing the evolution of speculative asset prices, there may be less agreement on where to start to build an improved paradigm. By and large, the view that has been adopted in the boundedly rational heterogeneous agent literature is to retain expected utility maximization as the goal of each agent but to allow the agents to have different risk preferences and different expectations, rather than the single homogeneous rational expectation, about future possible returns. The expectations differ since agents are assumed to have different information and beliefs. Thus the asset price modeling framework is based on the fact that trading is driven more by differences in expectations than by the random arrival of news events. Within this framework, a simple market of one risky asset and one risk-free asset, with agents having different expectations, is considered with two different types of utility functions and two different market-clearing mechanisms. The framework provides the basic elements and structure of the various models. The basic building blocks of this framework are portfolio optimization, agents' utility functions, the market-clearing mechanism, and expectations feedback.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1352111_code355571.pdf?abstractid=1352111

Heterogeneity, Market Mechanisms, and Asset Price Dynamics

http://depts.washington.edu/sce2003/Papers/312.pdf

Intrinsic Heterogeneity in Expectation Formation

Agent based-stock flow consistent macroeconomics: Towards a benchmark model

The global financial crisis has forced standard macroeconomics to re-examine the plausibility of its assumptions and the adequacy of the policy prescriptions flowing from those assumptions. We believe a renewal of macroeconomic thinking and macroeconomic modeling is possible by recognizing that our economies should be analyzed as complex adaptive systems. A coherent and exhaustive representation of the inter-linkages between the real and financial sides of the economy is vital as well. We propose a macroeconomic framework based on a novel combination of the Agent Based and Stock Flow Consistent approaches. This paper presents a benchmark model for this innovative approach. Our model depicts an economy with capital and credit in which different types of agents locally interact on different markets. We provide a detailed representation of individual agents’ balance sheets, ensuring the model accounting consistency at the micro, meso, and macro levels. We analyze the properties of our simulated economy under different configurations of agent heuristics, focusing in particular on the role of credit and investment. We explain in detail the logic followed to calibrate and validate the model. Results show that our benchmark model is able to reproduce many stylized facts observed in real world, thus representing a good starting point to test -- in the next works -- different economic policies and institutional setups. Finally, the relatively simple and flexible structure of the model opens up many possibilities for development of the framework along different lines, thus providing a fertile soil for new applications.

/pdf/agent-based-stock-flow-consistent-macroeconomics-towards-a-t5b49rvsef.pdf

Agent Based-Stock Flow Consistent Macroeconomics: Towards a Benchmark Model

We introduce a simple equilibrium model of a market for loans, where house- holds lend to rms based on heterogeneous expectations about their loan default

/pdf/animal-spirits-heterogeneous-expectations-and-the-emergence-13an2mqxg0.pdf

Animal Spirits, Heterogeneous Expectations and the Emergence of Booms and Busts

This paper develops the notion of a Large Type Limit (LTL) describing the average behavior of adaptive evolutionary systems with many trader types. It is shown that generic and persistent features of adaptive evolutionary systems with many trader types are well described by the large type limit. Stability and bifurcation routes to instability and strange attractors are studied. An increase in the "intensity of adaption" or in the diversity of beliefs may lead to deviations from the RE fundamental benchmark and excess volatility. Simple examples of LTL are able to generate important stylized facts, such as volatility clustering and long memory, observed in real financial data.

Evolutionary dynamics in financial markets with many trader types

This paper develops the notion of a Large Type Limit (LTL) describing the average behavior of adaptive evolutionary systems with many trader types. It is shown that generic and persistent features of adaptive evolutionary systems with many trader types are well described by the large type limit. Stability and bifurcation routes to instability and strange attractors are studied. An increase in the ``intensity of adaption'' or in the diversity of beliefs may lead to deviations from the RE fundamental benchmark and excess volatility. Simple examples of LTL are able to generate important stylized facts, such as volatility clustering andlong memory, observed in real financial data.

/pdf/evolutionary-dynamics-in-financial-markets-with-many-trader-3ig065t4ij.pdf

We introduce a simple equilibrium model of a market for loans, where households lend to firms based on heterogeneous expectations about their loan default probability. Agents select among heterogeneous expectation rules, based upon their relative performance. A small fraction of pessimistic traders already has a large aggregate effect, leading to a crisis characterized by high contract rates for loans and low output. Our stylized model illustrates how animal spirits and heterogeneous expectations amplify boom and bust cycles and how endogenous coordination on pessimistic expectations amplifies crises and slows down recovery.

/pdf/animal-spirits-heterogeneous-expectations-and-the-emergence-3oojm07n7f.pdf

William A. Brock

Papers

Animal Spirits, Heterogeneous Expectations and the Emergence of Booms and Busts

Evolutionary dynamics in financial markets with many trader types

Evolutionary dynamics in financial markets with many trader types

Animal Spirits, Heterogeneous Expectations and the Emergence of Booms and Busts