CFA Practice Question
In his research paper, an economics student finds that the consensus inflation estimation for the following year is not related to the actual inflation level the year before. However, the estimation error is often very large while displaying no pattern. Which of the following theories would this evidence support?
A. Rational anticipation forecast
B. Rational expectations hypothesis
C. Adaptive expectations hypothesis
Explanation: According to the rational expectations hypothesis, decision-makers form their expectations about the future based on all available information. Therefore a comparison of expected and realized inflation would show a random estimation error and no correlation with past estimates. The forecast is not always correct, but the errors tend to be random.
User Contributed Comments 5
| User | Comment |
|---|---|
| danlan | Error is random, so it's based on rational expecation hypothesis. If error shows some pattern, then it's based on adaptive hypothesis. |
| danlan | Rational shows pattern based on ALL available info, not only actual inflation level. |
| siggarusfigs | is A anything? |
| harrybay | no |
| ashish100 | Thanks everybody. Random -Rational Expectation (based on all info) Pattern - Adaptive Expectation. |