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IAI Actuarial Core Principles · Economic Modelling · Rational expectations theory and the efficient markets hypothesis

Which feature most clearly distinguishes rational expectations from adaptive expectations?

Rational expectations use all available information and knowledge of the economy's structure, so anticipated policy changes alter forecasts immediately. Adaptive expectations only revise gradually from past errors and can be systematically biased after a regime change.

  1. ARational expectations allow forecast errors to be systematically biased for long periods
  2. BAdaptive expectations use all available information, including knowledge of policy changes
  3. CRational expectations use the current model of the economy and all information, so anticipated policy changes affect forecasts immediatelyCorrect
  4. DAdaptive expectations never allow forecast errors
  5. Rational expectations depend only on past values of the variable

Explanation

Rational agents incorporate the structure of the economy and announced policy into forecasts at once. Adaptive agents revise only after observing past errors, so they can be systematically wrong during a regime change. The other options reverse these properties.

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