The Theory of Capital Markets. Rational Expectations and Efficient Markets. Adaptive Expectations. Adaptive Expectations Expectations depend on past experience only. Expectations are a weighted average of past experiences. Expectations change slowly over time. Rational Expectations.
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Rational Expectations and Efficient Markets
RET = Pt+1 – Pt + C
RETe = Pe t+1 – Pt + C
Pet+1 = Poft+1 which means RETet+1 = REToft+1
RETe = RETof = RET eq
Current prices are set so that the optimal forecast of RET equals
the equilibrium RET.