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Title:Predicting the unpredictable: Forecastable bubbles and business cycles under rational expectations PDF Logo
Authors:Gracia, Eduard
Issue Date:2012
Citation:[Journal:] Economics: The Open-Access, Open-Assessment E-Journal [Volume:] 6 [Issue:] 2012-41 [Pages:] 1-43
Abstract:A popular interpretation of the Rational Expectations/Efficient Markets hypothesis states that, if it holds, market valuations must follow a random walk; hence, the hypothesis is frequently criticized on the basis of empirical evidence against such a prediction. Yet this reasoning incurs what we could call the 'fallacy of probability diffusion symmetry': although market efficiency does indeed imply that the mean (i.e. 'expected') path must rule out any cyclical or otherwise arbitrage-enabling pattern, if the probability diffusion process is asymmetric the observed path will most closely resemble not the mean but the median, which is not subject to this condition. In this context, this paper develops an efficient markets model where the median path of Tobin's q ratio displays regular, periodic cycles of bubbles and crashes reflecting an agency problem between investors and producers. The model is tested against U.S. market data, and its results suggest that such a regular cycle does indeed exist and is statistically significant. The aggregate production model in Gracia (Uncertainty and Capacity Constraints: Reconsidering the Aggregate Production Function, 2011) is then put forward to show how financial fluctuations can drive the business cycle by periodically impacting aggregate productivity and, as a consequence, GDP growth.
Subjects:rational expectations
efficient markets
financial bubbles
stock markets
booms and crashes
Tobin's q
business cycles
economic rents
JEL:E22
E23
E32
G12
G14
Persistent Identifier of the first edition:doi:10.5018/economics-ejournal.ja.2012-41
Creative Commons License:http://creativecommons.org/licenses/by-nc/2.0/de/deed.en
Document Type:Article
Appears in Collections:Economics: The Open-Access, Open-Assessment E-Journal - Journal Articles

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