# 13-014/II (2013-01-14)

Author(s)
Cars Hommes, University of Amsterdam; Mei Zhu, Shanghai University of Finance and Economics
Keywords:
Bounded rationality; Stochastic consistent expectations equilibrium; Adaptive learning; Excess volatility; Inflation persistence
JEL codes:
E30; C62; D83; D84

This discussion paper led to an article in 'Journal of Economic Theory' (2014). Volume 150, pp. 778-814.

We propose behavioral learning equilibria as a plausible explanation of coordination of individual expectations and aggregate phenomena such as excess volatility in stock prices and high persistence in inflation. Boundedly rational agents use a simple univariate linear forecasting rule and correctly forecast the unconditional sample mean and first-order sample autocorrelation. In the long run, agents learn the best univariate linear forecasting rule, without fully recognizing the structure of the economy. The simplicity of behavioral learning equilibria makes coordination of individual expectations on such an aggregate outcome more likely. In a first application, an asset pricing model with AR(1) dividends, a unique behavioral learning equilibrium exists characterized by high persistence and excess volatility, and it is stable under learning. In a second application, the New Keynesian Phillips curve, multiple equilibria co-exist, learning exhibits path dep endence and inflation may switch between low and high persistence regimes.