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A MODEL OF NEAR-RATIONAL EXUBERANCE

Published online by Cambridge University Press:  09 March 2010

James Bullard
Affiliation:
Federal Reserve Bank of St. Louis
George W. Evans*
Affiliation:
University of Oregon, and University of St. Andrews
Seppo Honkapohja
Affiliation:
Bank of Finland
*
Address correspondence to: George W. Evans, Department of Economics, University of Oregon, Eugene, OR 97403-1285, USA; e-mail: gevans@uoregon.edu.

Abstract

We study how the use of judgment or “add-factors” in forecasting may disturb the set of equilibrium outcomes when agents learn by 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.

Type
Articles
Copyright
Copyright © Cambridge University Press 2010

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