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A new perspective to rational expectations: maximin rational expectations equilibrium

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Microsoft Word - EDP-1004 Economics Discussion Paper Series EDP-1107 A new perspective to rational expectations: maximin rational expectations equilibrium Luciano De Castro Marialaura Pesce Nicholas C. Yannelis January 2011 Economics School of Social Sciences The University of Manchester Manchester M13 9PL A new perspective to rational expectations: maximin rational expectations equilibrium∗ Luciano I. de Castro 1 Marialaura Pesce2 and Nicholas C. Yannelis3 Abstract: We introduce a new notion of rational expectations equilibrium (REE) called maximin rational expectations equilibrium (MREE), which is based on the maximin expected utility (MEU) formulation. In particular, agents maximize maximin expected utility conditioned on their own private information and the information that the equi- librium prices generate. Maximin equilibrium allocations need not to be measurable with respect to the private information of each individual and with respect to the information that the equilibrium prices generate, as it is in the case of the Bayesian REE. We prove that a maximin REE exists universally (and not generically as in Radner (1979) and Allen (1981)), it is efficient and incentive compatible. These results are false for the Bayesian REE. ∗We are grateful to David Schmeidler for helpful comments. 1Department of Managerial Economics and Decision Sciences Northwestern University, Evanston, IL 60208, USA e-mail: [email protected] 2Dipartimento di Matematica e Statistica, Universita´ di Napoli Federico II, Napoli 81026, ITALY e-mail: [email protected] 3Department of Economics University of Illinois at Urbana-Champaign, Urbana, IL 61801, USA and Economics - School of Social Sciences The University of Manchester, Oxford Road, Manchester M13 9PL, UK e-mail: [email protected], [email protected] 1 1 Introduction In seminal papers, Radner (1979) and Allen (1981) prove the generic existence of a rational

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