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Rethinking ExpectationsThe Way Forward for Macroeconomics$
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Roman Frydman and Edmund S. Phelps

Print publication date: 2013

Print ISBN-13: 9780691155234

Published to Princeton Scholarship Online: October 2017

DOI: 10.23943/princeton/9780691155234.001.0001

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Opening Models of Asset Prices and Risk to Nonroutine Change

Opening Models of Asset Prices and Risk to Nonroutine Change

(p.207) Chapter Six Opening Models of Asset Prices and Risk to Nonroutine Change
Rethinking Expectations

Roman Frydman

Michael D. Goldberg

Princeton University Press

This chapter considers an alternative approach to economic analysis, Imperfect Knowledge Economics (IKE), and introduces a model of asset prices and risk that has explicit mathematical microfoundations and yet remains open to nonroutine change. The IKE model consists of representations of individuals' preferences, forecasting behavior, constraints, and decision rules in terms of a set of causal (often called “informational”) variables, which portray the influence of economic policy, institutions, and other features of the social context. It also entails an aggregation rule and processes for the informational variables. The chapter examines irregular swings in asset prices and their relationship to financial risk. It also presents an IKE account of asset price swings before concluding with an analysis of contingent predictions of long swings and their compatibility with rationality.

Keywords:   economic analysis, Imperfect Knowledge Economics, asset prices, risk, microfoundations, nonroutine change, preferences, forecasting behavior, asset price swings, rationality

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