Formation of Rationally Heterogeneous Expectations

Abstract: This paper models expectation formation by taking into account that agents produce heterogeneous expectations due to model uncertainty, informational frictions and different capacities for processing information. We show that there are two general classes of steady states within this framework: those where strictly dominated forecasting rules vanish, and intrinsic heterogeneous steady states where a positive proportion of agents use a more costly perfect foresight. This demonstrates that intrinsic heterogeneity can also arise in a model where the forecasting rules are not equally costly, and do not exhibit identical performance in the long run.