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Structural stability and robustness to bounded rationality

Structural stability and robustness to bounded rationality
Structural stability and robustness to bounded rationality
The introduction of a small amount of bounded rationality into a model sometimes has little effect, and sometimes has a dramatic impact on predicted behavior. We call a model robust to bounded rationality if small deviations from rationality result only in small changes in the equilibrium set. We also say that a model is structurally stable if the equilibrium set (given fully rational agents) varies continuously with the parameter values of the model.
Our notions of a model and of rationality are quite broad, allowing us to cover cases in which bounded rationality refers to imperfect optimization, non-rational expectations, or arbitrary behavior by a subset of agents. We show that a model is robust to bounded rationality if and only if it is structurally stable. Thus, we can characterize which models will be robust to bounded rationality and which ones will not, independently of the exact form that bounded rationality takes. In addition, from our characterization it follows that introducing a small amount of bounded rationality will have large effects on predicted outcomes if and only if parameters are near a critical point where the equilibrium set changes in a discontinuous way
2
University of Southampton
Anderlini, Luca
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Canning, David
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Anderlini, Luca
da052378-2176-45a0-89e0-cbd0d7e43296
Canning, David
a4f37a2f-d71c-407a-ad72-cbf67e3b8136

Anderlini, Luca and Canning, David (2000) Structural stability and robustness to bounded rationality (Discussion Papers in Economics and Econometrics, 2) Southampton, UK. University of Southampton

Record type: Monograph (Discussion Paper)

Abstract

The introduction of a small amount of bounded rationality into a model sometimes has little effect, and sometimes has a dramatic impact on predicted behavior. We call a model robust to bounded rationality if small deviations from rationality result only in small changes in the equilibrium set. We also say that a model is structurally stable if the equilibrium set (given fully rational agents) varies continuously with the parameter values of the model.
Our notions of a model and of rationality are quite broad, allowing us to cover cases in which bounded rationality refers to imperfect optimization, non-rational expectations, or arbitrary behavior by a subset of agents. We show that a model is robust to bounded rationality if and only if it is structurally stable. Thus, we can characterize which models will be robust to bounded rationality and which ones will not, independently of the exact form that bounded rationality takes. In addition, from our characterization it follows that introducing a small amount of bounded rationality will have large effects on predicted outcomes if and only if parameters are near a critical point where the equilibrium set changes in a discontinuous way

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More information

Published date: 2000
Additional Information: JEL classification: C69, C79, D51, E19

Identifiers

Local EPrints ID: 33107
URI: http://eprints.soton.ac.uk/id/eprint/33107
PURE UUID: 55bf5148-c229-4566-8a8a-a57520b326dd

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Date deposited: 17 Jul 2006
Last modified: 15 Mar 2024 07:42

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Contributors

Author: Luca Anderlini
Author: David Canning

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