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Finance and Economics Discussion Series
The Finance and Economics Discussion Series logo links to FEDS home page Rational Error Correction
P.A. Tinsley

Abstract: Under general conditions, linear decision rules of agents with rational expectations are equivalent to restricted error corrections. However, empirical rejections of rational expectation restrictions are the rule, rather than the exception, in macroeconomics. Rejections often are conditioned on the assumption that agents aim to smooth only the levels of actions or are subject to geometric random delays. Generalizations of dynamic frictions on agent activities are suggested that yield closed-form, higher-order decision rules with improved statistical fits and infrequent rejections of rational expectations restrictions. Properties of these generalized ``rational'' error corrections are illustrated for producer pricing in manufacturing industries.

Keywords: Companion systems, error correction, producer pricing, rational expectations

Full paper (237 KB PDF) | Full paper (341 KB Postscript)

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Last update: August 19, 1998