Rational Diverse Beliefs and Economic Volatility
We next turn to models of diverse beliefs without private information. We explore work on Rational Belief Equilibria (i.e. RBE) starting with modeling beliefs. Agents do not know the structure of the dynamically complex economy but have data over a long time to enable an econometric computation of the empirical moments, on the basis of which they compute a commonly known empirical probability on sequences. A belief is then a model of deviations from the empirical probability. It is shown that to be rational a belief cannot be constant, creating an endogenous mechanism for market dynamics. For the development of an equilibrium theory, beliefs are treated as a vector of state variables and market belief is the distribution of individual beliefs. Market belief is an observable for which ample data is available and we review both data sources and applications which use such data. Much of the material reviewed covers the applications of this theory to the study of market dynamics.