A Model of Near-Rational Exuberance
40 Pages Posted: 7 Mar 2007
Date Written: January 1, 2008
We study how the use of judgment or "add-factors" in forecasting may disturb the set of equilibrium outcomes when agents learn using recursive methods. We isolate conditions under which new phenomena, which we call exuberance equilibria, can exist in a standard self-referential environment. Local indeterminacy is not a requirement for existence. We construct a simple asset pricing example and find that exuberance equilibria, when they exist, can be extremely volatile relative to fundamental equilibria.
Keywords: Learning, expectations, excess volatility, bounded rationality
JEL Classification: E520, E610
Suggested Citation: Suggested Citation