Model Averaging and Persistent Disagreement

16 Pages Posted: 6 Jul 2017 Last revised: 17 Jul 2019

See all articles by In-Koo Cho

In-Koo Cho

University of Illinois at Urbana-Champaign

Kenneth Kasa

Simon Fraser University (SFU) - Department of Economics

Date Written: 2017

Abstract

The authors consider the following scenario: Two agents construct models of an endogenous price process. One agent thinks the data are stationary, the other thinks the data are nonstationary. A policymaker combines forecasts from the two models using a recursive Bayesian model averaging procedure. The actual (but unknown) price process depends on the policymaker?s forecasts. The authors find that if the policymaker has complete faith in the stationary model, then beliefs and outcomes converge to the stationary rational expectations equilibrium. However, even a grain of doubt about stationarity will cause beliefs to settle on the nonstationary model, where prices experience large self-confirming deviations away from the stationary equilibrium. The authors show that it would take centuries of data before agents were able to detect their model misspecifications

JEL Classification: D84, C63

Suggested Citation

Cho, In-Koo and Kasa, Kenneth, Model Averaging and Persistent Disagreement (2017). Available at SSRN: https://ssrn.com/abstract=2997941 or http://dx.doi.org/10.20955/r.2017.279-294

In-Koo Cho (Contact Author)

University of Illinois at Urbana-Champaign ( email )

410 David Kinley Hall
1407 W. Gregory
Urbana, IL 61801
United States

Kenneth Kasa

Simon Fraser University (SFU) - Department of Economics ( email )

8888 University Drive
Burnaby, British Columbia V5A 1S6
Canada

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