LN6-RatExandEMH

LN6-RatExandEMH - RATIONAL EXPECTATIONS AND THE EFFICIENT MARKET HYPOTHESIS Pricing Future Random Payments Price of financial asset is expected

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RATIONAL EXPECTATIONS AND THE EFFICIENT MARKET HYPOTHESIS
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Pricing Future Random Payments • Price of financial asset is expected discounted flow of payments. •T h e w o r d expected ” is there because either payments or discount rates are random variables. • Price = Expected Present Value of Payments
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Expectations • Key question: – How do financial market participants form expectations? • The answer to this question is key if one wants to understand prices of financial assets. – For example, EH in term structure: what determines Ej m,t ??
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Rational Expectations • Theory about information set used by investors. • From intro stats: – Conditional expectation – Here refers to the information set available to investors when they forecast the future value of random variable x. – Prior to rational expectations, investors were assumed to used a “small” information set – E.g. Past values of x only (adaptive expectations) ) | ( 1 t t x E Ω + t Ω
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This note was uploaded on 11/20/2011 for the course ECON 420 taught by Professor Silous during the Spring '11 term at Emory.

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LN6-RatExandEMH - RATIONAL EXPECTATIONS AND THE EFFICIENT MARKET HYPOTHESIS Pricing Future Random Payments Price of financial asset is expected

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