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A new approach to the rational expectations equilibrium: existence, optimality and incentive compatibility

  • Luciano I. de Castro
  • Marialaura PesceEmail author
  • Nicholas C. Yannelis
Research Article

Abstract

Rational expectations equilibrium seeks a proper treatment of behavior under private information by assuming that the information revealed by prices is taken into account by consumers in their decisions. Typically agents are supposed to maximize a conditional expectation of state-dependent utility function and to consume the same bundles in indistiguishable states [see Allen (Econometrica 49(5):1173–1199, 1981), Radner (Econometrica 47(3):655–678, 1979)]. A problem with this model is that a rational expectations equilibrium may not exist even under very restrictive assumptions, may not be efficient, may not be incentive compatible, and may not be implementable as a perfect Bayesian equilibrium (Glycopantis et al. in Econ Theory 26(4):765–791, 2005). We introduce a notion of rational expectations equilibrium with two main features: agents may consume different bundles in indistinguishable states and ambiguity is allowed in individuals’ preferences. We show that such an equilibrium exists universally and not only generically without freezing a particular preferences representation. Moreover, if we particularize the preferences to a specific form of the maxmin expected utility model introduced in Gilboa and Schmeidler (J Math Econ 18(2):141–153, 1989), then we are able to prove efficiency and incentive compatibility. These properties do not hold for the traditional (Bayesian) Rational Expectation Equilibrium.

Keywords

Rational expectations Ambiguity aversion Efficiency Incentive compatibility 

JEL Classification

D50 D81 D82 

Notes

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Copyright information

© Springer-Verlag GmbH Germany, part of Springer Nature 2019

Authors and Affiliations

  • Luciano I. de Castro
    • 1
  • Marialaura Pesce
    • 2
    • 3
    Email author
  • Nicholas C. Yannelis
    • 4
  1. 1.Department of Economics, Henry B. Tippie College of BusinessThe University of IowaIowa CityUSA
  2. 2.Dipartimento di Scienze Economiche e StatisticheUniversitá di Napoli Federico IINaplesItaly
  3. 3.CSEFNaplesItaly
  4. 4.Department of Economics, Henry B. Tippie College of BusinessThe University of IowaIowa CityUSA

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