Discussion paper

DP8917 Bayesian Model Averaging, Learning and Model Selection

Agents have two forecasting models, one consistent with the unique rational expectations equilibrium, another that assumes a time-varying parameter structure. When agents use Bayesian updating to choose between models in a self-referential system, we find that learning dynamics lead to selection of one of the two models. However, there are parameter regions for which the non-rational forecasting model is selected in the long-run. A key structural parameter governing outcomes measures the degree of expectations feedback in Muth's model of price determination.

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Citation

Honkapohja, S, T Sargent, G Evans and N Williams (eds) (2012), “DP8917 Bayesian Model Averaging, Learning and Model Selection”, CEPR Press Discussion Paper No. 8917. https://cepr.org/publications/dp8917