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Rational Expectations Equilibrium Under Ambiguity ∗ July 20 , 2015

Rational expectations equilibrium (REE) seeks a proper treatment of behavior under private information by assuming that the information revealed by prices is taken into account by agents in their decisions. Despite being an important advancement in economic theory, REE has been the subject of intense criticism since its inception. The criticisms usually focus on the unrealistic behavior of agents in face of uncertainty. Among those criticisms, rarely appears the fact that REE may fail to exist Kreps (1977). This paper suggests that the two kind of problems are connected and a deeper understanding of the existence problem may lead to advances in the other. Why sometimes a REE does not exist? Essentially, there may be an inconsistency between the behavior with the information provided by prices and the information that this behavior actually reveals. Since the 80’s, the usual reaction to this problem is to dismiss it, since existence may be guaranteed generically Radner (1979); Allen (1981). However, lack of equilibrium existence may be a sign of the need of an alternative. In this paper, we present such an alternative, i.e., we explore the implications of introducing ambiguity aversion instead of the usual Bayesian approach in rational expectations. We show that if individuals’ preferences are variational (i.e., satisfy a general form of ambiguity aversion), then a REE exists universally and not only generically. If we particularize the preferences to a particular form of the maximin expected utility (MEU) model introduced in Gilboa and Schmeidler (1989), then we are able to prove efficiency and incentive compatibility, properties that do not hold for Bayesian Rational Expectation Equilibria.