Download This PaperRational Expectations Models with Higher-Order Beliefs
67 Pages Posted: 8 Jul 2021 Last revised: 5 May 2023
Date Written: May 5, 2023
Abstract
We develop a method of solving rational expectations models with dispersed information and
dynamic strategic complementarities. In these types of models, the equilibrium outcome hinges
on an infinite number of higher-order expectations which require an increasing number of state
variables to keep track of. Despite this complication, we prove that the equilibrium outcome always
admits a finite-state representation when the signals follow finite ARMA processes. We also show
that such finite-state result may not hold with endogenous information aggregation. We further
illustrate how to use the method to derive comparative statics, characterize equilibrium outcomes
in HANK-type network games, reconcile with empirical evidence on expectations, and integrate
incomplete information with bounded rationality in general equilibrium.
Keywords: Higher-order expectations, dynamic complementarity, general equilibrium
JEL Classification: D8, E1
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