Rational expectations is not generally valid for econometric models : Evidence from stock market data

Research output: Journal Publications and ReviewsRGC 21 - Publication in refereed journalpeer-review

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Original languageEnglish
Pages (from-to)149-163
Journal / PublicationPacific Economic Review
Issue number3
Publication statusPublished - 1997
Externally publishedYes


In applying the rational expectations hypothesis to generate expectations in an econometric model it is assumed that (1) the model itself is capable of generating reasonable forecasts of all required expectations variables included in the model, and that (2) the economic agents whose behavior is being modeled act as if they form their psychological expectations as conditional mathematical expectations generated by the model. Both assumptions can be invalid, as demonstrated by the historical data on Hong Kong stock prices and by the successful application of the adaptive expectations hypothesis to explain panel data of prices of individual stocks and aggregate time series data on stock price indices of the United States and of Hong Kong.