Open Yale CoursesECON 251: Financial TheoryLecture 15 - Uncertainty and the Rational Expectations Hypothesis: Applications toPredicting Stock Prices, Default Probabilities, and Hyperbolic Discounting<< previous session | next session >>Overview:According to the rational expectations hypothesis, traders know the probabilities of future events, and value uncertainfuture payoffs by discounting their expected value at the riskless rate of interest. Under this hypothesis the bestpredictor of a firm's valuation in the future is its stock price today. In one famous test of this hypothesis, it was foundthat detailed weather forecasts could not be used to improve on contemporaneous orange prices as a predictor of futureorange prices, but that orange prices could improve contemporaneous weather forecasts. Under the rational expectationshypothesis you can infer more about the odds of corporate or sovereign bonds defaulting by looking at their prices thanby reading about the financial condition of their issuers.
This is the end of the preview.
access the rest of the document.