ECON 3430 Lecture Notes - Lecture 13: Efficient-Market Hypothesis, Forecast Error, Rational Expectations

• School: York University
• Department: Economics
• Course: ECON 3430
• Professor: Ahmet Akyol

Document Summary

Chapter 7 the stock market, the theory of rational expectations, and the efficient market hypothesis. Lecture 13: the incentives for equating expectations with optimal forecasts are strong in financial markets. Rational expectations theory leads to two implications: if there is a change in the way a variable moves, the way in which expectations of the variable are formed will change as well. I. e. , changes in the conduct of monetary policy: the forecast errors of expectations will, on average, be zero and cannot be predicted ahead of time. R = the rate of return on the security. Pt+1 = price at time t+1 (end of the holding period) Pt = price at time t (beginning of the holding period) In an efficient market, a security"s price fully reflects all available information. Important implication of the efficient market hypothesis is that stock prices should approximate a random walk: future changes in stock prices should, for all practical purposes, be unpredictable.