Research Discussion Papers, Bank of Finland
No 7/2006:
Adaptive learning in an expectational difference equation with several lags: selecting among learnable REE
Mikael Bask ()
Abstract: It is demonstrated in this paper that adaptive learning in
least squares sense may be incapable to reduce, in a satisfactory way, the
number of attainable equilibria in a rational expectations model. The model
inves-tigated, as an illustration, is the monetary approach to exchange
rate determination that is augmented with technical trading in the currency
market in the form of moving averages since it is the most commonly used
technique according to questionnaire surveys. Because of technical trading
in foreign exchange, the current exchange rate is dependent on jmax lags of
the exchange rate, and the model has, therefore jmax + 1 nonbubble rational
expectations equilibria (REE), where most of them are adaptively learnable.
Howe-ver, by assuming that a solution to the model should have a solution
to a nested model as its limit, it is possible to single out a unique
equilibrium among the adaptively learnable equilibria that is economically
meaningful.
Keywords: asset pricing; heterogenous agents; least squares learnability; rational expectations equilibria and technical trading; (follow links to similar papers)
JEL-Codes: C62; F31; G12; (follow links to similar papers)
37 pages, June 7, 2006
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