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Rational expectations

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Definition of Rational expectations

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Rational expectations

The idea that people rationally anticipate the future and respond to what they see ahead.


Rational Expectations

The best forecasts that can be made given the data available and knowledge of how the economy operates. rational expectations implies random errors, no systematic errors.



Related Terms:

Biased expectations theories

Related: pure expectations theory.


Expectations hypothesis theories

Theories of the term structure of interest rates which include the pure
expectations theory, the liquidity theory of the term structure, and the preferred habitat theory. These theories
hold that each forward rate equals the expected future interest rate for the relevant period. These three theories
differ, however, on whether other factors also affect forward rates, and how.
expectations theory of forward exchange rates A theory of foreign exchange rates that holds that the
expected future spot foreign exchange rate t periods in the future equals the current t-period forward exchange
rate.


expectations theory of exchange rates

Theory that expected spot exchange rate equals the forward rate.


Homogenous expectations assumption

An assumption of Markowitz portfolio construction that investors
have the same expectations with respect to the inputs that are used to derive efficient portfolios: asset returns,
variances, and covariances.



Irrational call option

The implied call imbedded in the MBS. Identified as irrational because the call is
sometimes not exercised when it is in the money (interest rates are below the threshold to refinance).
Sometimes exercised when not in the money (home sold without regard to the relative level of interest rates).


Local expectations theory

A form of the pure expectations theory which suggests that the returns on bonds
of different maturities will be the same over a short-term investment horizon.


Rational Expectations Image 2

Operational Earnings Management

Management actions taken in the effort to create stable
financial performance by acceptable, voluntary business decisions. An example: a special discount
promotion to increase flagging sales near the end of a quarter when targets are not being met.


operational plan

a formulation of the details of implementing
and maintaining an organization’s strategic plan;
it is typically formalized in the master budget


Operationally efficient market

Also called an internally efficient market, one in which investors can obtain
transactions services that reflect the true costs associated with furnishing those services.


Pure expectations theory

A theory that asserts that the forward rates exclusively represent the expected
future rates. In other words, the entire term structure reflects the markets expectations of future short-term
rates. For example, an increasing sloping term structure implies increasing short-term interest rates. Related:
biased expectations theories


Return-to-maturity expectations

A variant of pure expectations theory which suggests that the return that an
investor will realize by rolling over short-term bonds to some investment horizon will be the same as holding
a zero-coupon bond with a maturity that is the same as that investment horizon.



 

 

 

 

 

 

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