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

Which of the following is a feature that distinguishes rational expectations from adaptive expectations?

Rational expectations respond immediately to new information such as announced policy changes, because agents are forward-looking. Adaptive expectations change only after past forecast errors are observed. Rational expectations do not mean perfect foresight; they only imply forecasts that are unbiased and free of systematic errors.

  1. ARational expectations rely only on past values of the variable being forecast
  2. BRational expectations allow agents to make systematic errors that persist for many periods
  3. CRational expectations assume that agents have no knowledge of government policy
  4. DRational expectations can respond immediately to announced policy changes, whereas adaptive expectations adjust only after forecast errors occurCorrect
  5. Rational expectations require all agents to forecast perfectly in every period

Explanation

Rational agents use forward-looking information such as announced policy, so expectations shift at once. Adaptive agents revise only after observing past errors. Rational expectations do not imply perfect foresight, only unbiased forecasts without systematic error.

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