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Working Paper 2007-009B

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"A Model of Near-Rational Exuberance"
by James B. Bullard, George W. Evans, and Seppo Honkapohja

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

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Category > Monetary Policy/Macroeconomics
Author > James B. Bullard