ABSTRACT: This paper extends
the macroeconomic learning literature by allowing agents to test the
specification of
their models. It studies the
following problem. An agent takes actions based on a possibly misspecified
model. The agent is 'large',
in the sense that his actions influence the model he is trying to
learn about.
The agent is aware of potential
model misspecification and tries to detect it, in real-time,
using an econometric
specification test.
If his model fails the test, he formulates a new model.
If his model passes the test, he uses it implement
a policy based on the provisional assumption that the current model is correctly
specified, and will not change in the future.
We claim
this testing and model validation process is an accurate description of
many macroeconomic policy
problems. Unfortunately, the
dynamics produced by this process are not well understood. We make
progress on this
problem by exploiting results from the
large deviations literature. Our analysis can be interpreted as
providing a selection
criterion for self-confirming
equilibria, based on their 'robustness'. Robust self-confirming
equilibria survive repeated
specificationi tests, and are
characterized by their large deviation rate functions. An application
to postwar U.S. monetary
policy suggests that model validation
may help explain the persistence of the Fed's belief in an exploitable
Phillips Curve.
Asset Prices in a Time Series Model with Perpetually Disparately Informed, Competitive Traders
(with Todd Walker and Charles Whiteman)
ABSTRACT: This paper develops a
dynamic asset pricing model with persistent heterogeneous beliefs. The
model
features competitive traders who receive
idiosyncratic signals of an underlying fundamentals process. We adapt
Futia's (1981) frequency domain methods
to derive conditions on the fundamentals that guarantee noninvertibility
of the
mapping between market data and the
underlying shocks to agents' information sets. When these conditions are
satisfied,
agents must 'forecast the forecasts
of others'. The paper provides an explicit analytical characterization
of the resulting
higher-order belief dynamics. These
additional dynamics can explain apparent violations of variance bounds
and
rejections of cross-equation restrictions.
(slides)