On the structure and diversity of rational beliefs

Kurz, Mordecai

doi:10.1007/bf01213817

Cited by 274 publications

(148 citation statements)

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“…In period 1 agents trade a risky asset using leverage where the risky asset pays either a High or Low dividend. They hold diverse probabilities of the High payoff which are RB in the sense of Kurz (1994). The distribution of their forecasts is specified to be wide and impacts the speculation level and use of leverage.…”

Section: The Impact Of Diverse Beliefs: a Brief Summary Of Results Inmentioning

confidence: 99%

“…The first group consists of Kurz and Motolese (2011), Guo et al (2011), and Nielsen (2011. These adopt the Rational Belief (RB) approach due to Kurz (1994 and assume agents are rational but hold diverse beliefs due to their incomplete knowledge about the complex economy. The true dynamics is assumed non-stationary due to time-varying technology and institutions in which the structure changes faster than can be learned with precision from data.…”

Section: Why Are Beliefs Diverse?mentioning

confidence: 99%

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Symposium: on the role of market belief in economic dynamics, an introduction

Kurz

2010

Econ Theory

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entitled "When Are Diverse Beliefs Central?" They reflect the rapidly growing literature on the impact of diverse beliefs. It may thus be helpful to the reader if I use this introduction to highlight some ideas of this literature as reflected in the papers of this volume.As the era of Rational Expectations (in short RE) comes to a close it is important to clarify two points. First, the success of RE in disciplining macroeconomic modeling should not obscure the fact that the term "rational" is merely a label. Rationality of actions and rationality of beliefs have little to do with each other and using the term "rational" in RE has tended to brand other beliefs as "irrational." Studying axioms of belief rationality is actually a fruitful area of research that can fill the wide open space between RE and true irrational beliefs.A second point relates to private information. Not wishing to contradict RE, many adopted the device of asymmetric private information as the "cause" of diverse beliefs. Indeed, some view diverse beliefs as equivalent to asymmetric information. This is theoretically and empirically the wrong solution and in Kurz (2008Kurz ( , 2009) I explain why. It suffices to say that in large markets behavior under private information is different from behavior under diverse beliefs with common information. Also, all empirical evidence associates diverse forecasts with diverse modeling or diverse interpretation of public information. Finally, due to stochastic independence of private information over agents and time, RE models with asymmetric private information fail to deliver the key dynamic properties that are the central implications of I thank George Evans, Carsten Nielsen, Volker Wieland and Mike Wolters for constructive comments on earlier drafts of this Introduction.

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Section: The Impact Of Diverse Beliefs: a Brief Summary Of Results Inmentioning

confidence: 99%

Section: Why Are Beliefs Diverse?mentioning

confidence: 99%

Symposium: on the role of market belief in economic dynamics, an introduction

Kurz

2010

Econ Theory

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“…These two papers build on the Rational Belief Equilibrium of Kurz (1994). The Rational Belief approach begins with the premise that the economy is nonstationary and that agents have an infinite history of data with which they compute the stationary empirical measure for observed variables.…”

Section: Discussion Of Related Researchmentioning

confidence: 99%

Business cycle amplification with heterogeneous expectations

Branch

McGough

2010

Econ Theory

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This paper studies the implications for business cycle dynamics of heterogeneous expectations in a stochastic growth model. The assumption of homogeneous, rational expectations is replaced with a heterogeneous expectations model where a fraction of agents hold rational expectations and the remaining fraction adopt parsimonious forecasting models that are, in equilibrium, optimal within a restricted class. Our approach nests the literature on rational expectations in business cycle models with a recent approach based on adaptive learning. We demonstrate that (i.) heterogeneous expectations can lead to substantial improvement in the internal propagation of equilibrium business cycle models and (ii.) the internal propagation depends on the degree of heterogeneity. A calibrated model with heterogeneity provides a closer fit to business cycle data than its representative agent, rational expectations counterpart.

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“…Kurz (1994) defined a belief to be rational if it generates the same long-run empirical frequencies as the data. In a stationary economic system there is a unique rational belief.…”

Section: Heterogeneous Priorsmentioning

confidence: 99%

Bubbles, Crises, and Heterogeneous Beliefs

Xiong

2013

Handbook on Systemic Risk

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This paper reviews the quickly growing literature that builds on heterogeneous beliefs, a widely observed attribute of individuals, to explain bubbles, crises, and endogenous risk in financial markets.Wei Xiong Princeton University Department of Economics Bendheim Center for Finance Princeton, NJ 08450 and NBER wxiong@princeton.edu 1The history of financial markets has been dotted with episodes of bubbles, during which market values of assets vastly exceeded reasonable assessments of their fundamental value. Asset price bubbles can lead to severe economic consequences ranging from wasteful over-investment and frenzied trading during booms to devastating financial crises and depressed real economies during busts. Economists have emphasized many aspects of bubbles and crises. Minsky (1974) advocated the view that excessive expansion of bank credit due to optimism can fuel a speculative euphoria and slowly lead the economy to a crisis. Kindleberger (1978) stressed that irrationally optimistic expectations frequently emerge among investors in the late stages of major economic booms and lead firm managers to over-invest, over-promise, and over-leverage, which sow the seeds for an eventual collapse after they fail to deliver on their promises.Shiller (2000) highlighted a host of psychological biases people use in forming a feedback mechanism, through which initial price increases caused by certain initial precipitating factors such as new technology innovations feed back into even higher asset prices through increased investor confidence and expectations. Allen and Gale (2007) focused on agency problems of professional managers who actively seek unwarranted risk, which leads to bubbles and crises.This chapter reviews a quickly growing body of work that was started by Harrison and Kreps (1978) that studies bubbles and crises based on heterogeneous beliefs, a widely observed attribute of individuals.In a market in which agents disagree about an asset's fundamental and short sales are constrained, an asset owner is willing to pay a price higher than his own expectation of the asset's fundamental because he expects to resell the asset to a future optimist at an even higher price. Such speculative behavior leads to a bubble component in asset prices. This approach does not require a substantial amount of aggregate belief distortions to generate a significant price bubble. Instead, the bubble component builds on the fluctuations of investors' heterogeneous beliefs. Even when investors' aggregate beliefs are unbiased, intensive fluctuations of their heterogeneous beliefs can lead to a significant price bubble through frenzied trading (e.g., Scheinkman and Xiong (2003)). This approach is flexible enough to incorporate several important aspects of bubbles and crises, such as over-investment (e.g., Bolton, ) and crashes (e.g., Abreu and Brunnermeier (2003) and Hong and Stein (2003)). Heterogeneous beliefs can also lead to credit cycles (e.g., Geanakoplos (2010)). The speculation induced by heterogeneous beliefs also lea...

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On the structure and diversity of rational beliefs

Cited by 274 publications

References 18 publications

Symposium: on the role of market belief in economic dynamics, an introduction

Symposium: on the role of market belief in economic dynamics, an introduction

Business cycle amplification with heterogeneous expectations

Bubbles, Crises, and Heterogeneous Beliefs

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