Information acquisition and formation of expectations.

This dissertation deals with issues of learning and convergence to rational expectations (RE). The first essay addresses conceptual questions involved in the rational expectations hypothesis. The second essay focuses on an adaptive-evolutionary approach to expectations formation. It shows that in a simple and stable environment, even agents lacking any explicit foresight capabilities will converge toward what may be identified as a rational expectations equilibrium (REE). The third essay asks: How do rational agents use available information to form optimal expectations? What are the dynamics of learning that precede Muthian expectations? These questions are discussed in the context of a simple linear model with optimal forecasts. In the fourth essay three related issues are raised in the context of a constant absolute risk aversion model with two groups of traders and asymmetric information. First, will traders in a risky asset market learn Muthian expectations when they initially lack the necessary information? This is a question of learning and convergence. The uninformed traders learn about the distribution of returns from observations of prices and dividends. Learning is boundedly rational since it is based on a mispecification of the true likelihood function. However, learning is convergent and asymptotically the uninformed traders form RE. Second, will uninformed traders earn low returns as a result of poor forecasts, and will the informed traders dominate the market? This is an evolutionary, or survival of the fittest, argument, and it is shown not to hold in this model. Third, if some traders are boundedly rational, will the sophisticated traders restore the market to a REE where prices depend only on 'fundamentals', as implied by the Efficient Market Hypothesis? No, since market dynamics depend on the uninformed forecasts, and are not fully specified by the fundamentals. The market converges asymptotically to a REE where prices depend only on fundamentals and the market is efficient.PhDEconomicsUniversity of Michigan, Horace H. Rackham School of Graduate Studieshttp://deepblue.lib.umich.edu/bitstream/2027.42/105192/1/9116189.pdfDescription of 9116189.pdf : Restricted to UM users only