Self-justified equilibria in dynamic economies with heterogenous agents

Abstract

In this paper I introduce the concept of \lq\lq self-justified \rq\rq equilibrium as an alternative to rational expectations equilibrium. In a self-justified equilibrium agents' expectations can be described by finite sets and agents forecast future prices by extrapolation. The expectations are correct (i.e. "self-justified" ) for a fixed number of points but the agents' extrapolation method might lead to incorrect forecasts along an equilibrium path. Unlike recursive rational expectations equilibria, self-justified equilibria always exist and can be approximated numerically. Error analysis for approximate solutions is straightforward.