Model reference adaptive expectations in Markov-switching economies

Francesco Carravetta and Marco Sorge

Economic Modelling, 2013, vol. 32, issue C, 551-559

Abstract: This paper offers a theory of model reference adaptive beliefs as a selection device in Markov-switching economies under equilibrium indeterminacy. Consistent with the classical rational choice paradigm, our theory requires that endogenous expectations be replaced with a general-measurable function of the observable states of the model, to be determined optimally. This forecasting function is derived as the regime-independent feedback control minimizing the mean-square deviation of the equilibrium path from the corresponding perfect-foresight state motion (the reference model). We show that model reference adaptive expectations always generate a rational expectations equilibrium, irrespective of the presence of nonlinearities and/or imperfect information. Under equilibrium indeterminacy, this forecasting mechanism enforces the unique mean-square stable solution producing nearly perfect-foresight dynamics.

Keywords: Rational expectations; Markov-switching dynamic systems; Dynamic programming; Time-varying Kalman filter (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:32:y:2013:i:c:p:551-559

DOI: 10.1016/j.econmod.2013.02.033

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