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Article

Christopher G. Reddick

An exciting opportunity that many advanced industrial democracies faced in the late 1990s was the movement from budgetary deficit to surplus. This came after years of…

Abstract

An exciting opportunity that many advanced industrial democracies faced in the late 1990s was the movement from budgetary deficit to surplus. This came after years of persistent deficits. Traditional decisionmaking theories such as budgetary incrementalism failed to explain this longrun relationship, since it has been inherently a short-run theory. This paper uses rational expectations theory to demonstrate its relationship to budgetary decision-making reforms and the deficit (surplus) for Canada, the UK and the United States. The results demonstrated that there was an intertemporal budget constraint in operation in the three countries, and decision-makers at the macro level used rational expectations in the formulation of their annual budget. In the theory, budget actors strived to balance their budget, but did so over the longrun as opposed to the short-run incrementalist interpretation.

Details

Journal of Public Budgeting, Accounting & Financial Management, vol. 16 no. 3
Type: Research Article
ISSN: 1096-3367

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Article

David Blake

The different types of estimators of rational expectations modelsare surveyed. A key feature is that the model′s solution has to be takeninto account when it is estimated…

Abstract

The different types of estimators of rational expectations models are surveyed. A key feature is that the model′s solution has to be taken into account when it is estimated. The two ways of doing this, the substitution and errors‐in‐variables methods, give rise to different estimators. In the former case, a generalised least‐squares or maximum‐likelihood type estimator generally gives consistent and efficient estimates. In the latter case, a generalised instrumental variable (GIV) type estimator is needed. Because the substitution method involves more complicated restrictions and because it resolves the solution indeterminacy in a more arbitary fashion, when there are forward‐looking expectations, the errors‐in‐variables solution with the GIV estimator is the recommended combination.

Details

Journal of Economic Studies, vol. 18 no. 3
Type: Research Article
ISSN: 0144-3585

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Book part

Fabio Milani

This paper surveys the treatment of expectations in estimated Dynamic Stochastic General Equilibrium (DSGE) macroeconomic models.A recent notable development in the…

Abstract

This paper surveys the treatment of expectations in estimated Dynamic Stochastic General Equilibrium (DSGE) macroeconomic models.

A recent notable development in the empirical macroeconomics literature has been the rapid growth of papers that build structural models, which include a number of frictions and shocks, and which are confronted with the data using sophisticated full-information econometric approaches, often using Bayesian methods.

A widespread assumption in these estimated models, as in most of the macroeconomic literature in general, is that economic agents' expectations are formed according to the Rational Expectations Hypothesis (REH). Various alternative ways to model the formation of expectations have, however, emerged: some are simple refinements that maintain the REH, but change the information structure along different dimensions, while others imply more significant departures from rational expectations.

I review here the modeling of the expectation formation process and discuss related econometric issues in current structural macroeconomic models. The discussion includes benchmark models assuming rational expectations, extensions based on allowing for sunspots, news, sticky information, as well as models that abandon the REH to use learning, heuristics, or subjective expectations.

Details

DSGE Models in Macroeconomics: Estimation, Evaluation, and New Developments
Type: Book
ISBN: 978-1-78190-305-6

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Article

Franz Fuerst and Anna‐Maija Grandy

Expectations of future market conditions are acknowledged to be crucial for the development decision and hence for shaping the built environment. The purpose of this paper…

Abstract

Purpose

Expectations of future market conditions are acknowledged to be crucial for the development decision and hence for shaping the built environment. The purpose of this paper is to study the central London office market from 1987 to 2009 and test for evidence of rational, adaptive and naive expectations.

Design/methodology/approach

Two parallel approaches are applied to test for either rational or adaptive/naive expectations: vector auto‐regressive (VAR) approach with Granger causality tests and recursive OLS regression with one‐step forecasts.

Findings

Applying VAR models and a recursive OLS regression with one‐step forecasts, the authors do not find evidence of adaptive and naïve expectations of developers. Although the magnitude of the errors and the length of time lags between market signal and construction starts vary over time and development cycles, the results confirm that developer decisions are explained, to a large extent, by contemporaneous and historic conditions in both the City and the West End, but this is more likely to stem from the lengthy design, financing and planning permission processes rather than adaptive or naive expectations.

Research limitations/implications

More generally, the results of this study suggest that real estate cycles are largely generated endogenously rather than being the result of large demand shocks and/or irrational behaviour.

Practical implications

Developers may be able to generate excess profits by exploiting market inefficiencies but this may be hindered in practice by the long periods necessary for planning and construction of the asset.

Originality/value

This paper focuses the scholarly debate of real estate cycles on the role of expectations. It is also one of very few spatially disaggregate studies of the subject matter.

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Book part

Tiziana Assenza, Te Bao, Cars Hommes and Domenico Massaro

Expectations play a crucial role in finance, macroeconomics, monetary economics, and fiscal policy. In the last decade a rapidly increasing number of laboratory…

Abstract

Expectations play a crucial role in finance, macroeconomics, monetary economics, and fiscal policy. In the last decade a rapidly increasing number of laboratory experiments have been performed to study individual expectation formation, the interactions of individual forecasting rules, and the aggregate macro behavior they co-create. The aim of this article is to provide a comprehensive literature survey on laboratory experiments on expectations in macroeconomics and finance. In particular, we discuss the extent to which expectations are rational or may be described by simple forecasting heuristics, at the individual as well as the aggregate level.

Details

Experiments in Macroeconomics
Type: Book
ISBN: 978-1-78441-195-4

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Article

Francesco Strati

The causes for the formation of a bubble in the collateral market when agents are provided with homogeneous expectations are explored. This bubbly dynamics will define a…

Abstract

Purpose

The causes for the formation of a bubble in the collateral market when agents are provided with homogeneous expectations are explored. This bubbly dynamics will define a sufficient condition for deleveraging.

Design/methodology/approach

Theoretical approach with neutral deleveraging.

Findings

Findings of the study are defined sufficient conditions for a behavioral rational bubble's formation in a market of collateral and the subsequent deleveraging. The crowd-in effect of the representative bubble is caused by errors in extrapolating information and thus by representativeness, while the crowd-out effect of deleveraging is set off by reverting to a rational heuristic.

Research limitations/implications

The limit is that it is a homogeneous expectations approach, the implication is that cannot be rational speculation.

Practical implications

Even in a simple model of homogeneous expectations a bubble may arise with serious effect on the demand side: models that detect just rational mispricings cannot account for behavioral components that have financial and real effects.

Originality/value

The paper defines how deleveraging may occur even in case of homogeneous expectations. The latter should not be seen just as a limit but also as a signal of the importance of being aware of behavioral components.

Details

Review of Behavioral Finance, vol. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 1940-5979

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Article

Shaun Hargreaves Heap

Incorrect inflationary expectations affect the unemployment rate,hence the question of how expectations are formed is crucial. Examinestwo hypotheses which have dominated…

Abstract

Incorrect inflationary expectations affect the unemployment rate, hence the question of how expectations are formed is crucial. Examines two hypotheses which have dominated the discussion: the adaptive (AEH) and the rational expectations hypothesis (REH). During the 1980s it was assumed that REH was to be preferred to AEH, but various problems with REH have emerged. Focuses on two of these problems: whether participants in the labour market have the requisite information; and the presence of multiple RE equilibria. It may therefore be necessary for agents to co‐ordinate their expectations. Suggests that institutions of the labour market might hold the key to this question of co‐ordination.

Details

International Journal of Manpower, vol. 14 no. 9
Type: Research Article
ISSN: 0143-7720

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Book part

Marcin Wolski

We test the determinacy properties of the standard and financial-sector-augmented Taylor rules in a new Keynesian model with a presence of banking activities. We extend…

Abstract

We test the determinacy properties of the standard and financial-sector-augmented Taylor rules in a new Keynesian model with a presence of banking activities. We extend the basic fully rational environment to the setting with heterogeneous expectations. We observe that the benefits from extra financial targeting are limited. Financial targeting, if well designed, can compensate for the improper output-gap targeting through the financial-production channel. The analysis demonstrates however possible threats resulting from the misspecification of the augmented rule. A determinate mix of output-gap and inflation weights can turn indeterminate if compensated by too extreme financial targeting. The results are robust to the presence of heterogeneous expectations.

Details

Monetary Policy in the Context of the Financial Crisis: New Challenges and Lessons
Type: Book
ISBN: 978-1-78441-779-6

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Article

Feng Gao, Fengming Song and Jun Wang

The paper aims to test the rationalexpectations hypothesis using data from the Chinese stock market.

Abstract

Purpose

The paper aims to test the rationalexpectations hypothesis using data from the Chinese stock market.

Design/methodology/approach

The rationalexpectations hypothesis plays a critical role in economic and financial studies. However, it is unclear whether this hypothesis is consistent with real‐world decision making since existing empirical results are mixed. This paper tests the hypothesis directly using survey data from China's stock market by developing a technique to analyze discrete or limited independent‐variable models.

Findings

The paper shows that in China's stock market survey forecasts are overly optimistic, especially with positive information, and can be improved slightly using past information.

Originality/value

The paper develops a technique to analyze the discrete or limited independent‐variable model. Testing with Chinese stock market data provides some insights into the characteristics of emerging markets.

Details

The Journal of Risk Finance, vol. 9 no. 5
Type: Research Article
ISSN: 1526-5943

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Book part

David Elkayam and Alex Ilek

In this chapter, we analyze the information content of data on inflationary expectations derived from the Israeli bond market. The results indicate that these expectations

Abstract

In this chapter, we analyze the information content of data on inflationary expectations derived from the Israeli bond market. The results indicate that these expectations are unbiased and efficient with respect to the variables considered. In other words, we cannot reject the hypothesis that these expectations are rational.

The existence of continuous data of this type, which is unique to the Israeli economy, enables us to test a number of hypotheses concerning the nature of price adjustment. The study found that expected inflation is a primary factor in the explanation of current inflation. This result is in agreement with the neo-Keynesian approach according to which the adjustment of prices is costly, and as a result, price increases in the present are determined primarily by expectations of future price increases. It was also found that inflation in Israel is better explained by the neo-Keynesian approach than by the classical approach or the “lack of information” approach according to which current inflation is determined by past, rather than current, inflationary expectations.

Another issue examined in this study is whether inflationary inertia existed in Israel during the 1990s. From conventional estimation of an inflation equation (i.e., using future inflation as proxy for expectations), one can get the impression that there was strong inflationary inertia during this period. However, when data on inflationary expectations from the bond market were used in the estimation, this inertia (i.e., lagged inflation) became negative (and insignificant). This finding raises the possibility that inflationary inertia that is found elsewhere is not a structural phenomenon but an outcome of lack of reliable data on inflationary expectations.

Details

Measurement Error: Consequences, Applications and Solutions
Type: Book
ISBN: 978-1-84855-902-8

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