Posted in Finance, Accounting and Economics Terms, Total Reads: 678
Definition: Adaptive Expectations
This term refers to basing of future expectations while conjecturing on similar happenings in the past. You are said to be expecting adaptively when you expect a trend to repeat in future because the same series of events in the past led to a particular result. Let us try to bring this idea to life by taking the example of one of the most familiar macroeconomic term – Inflation. During the 10 year regime of UPA-1 and UPA-II combined, not only people but also economists predicted inflation rate to be rising based on the simple fact that such had been the trend unabated in the past years. Nothing had changed strikingly loud to insinuate to the fact that inflation would not go up in the coming years. This theory of adaptive expectation can be said to be in play then. Mathematically speaking; Pe = α(Pt. -1), where Pe is the index of this year, and Pt is the index of the previous year and α is any number between 0 and 1 indicating the level of dependence. To make our prediction more reliable and accurate, we might want to consider the effect of multiple preceding years. But, as years pass, it might be logical to think that the different weights should be given to different years as the impact of aging years on the current years would be relatively less. Putting it simply, the recent year will be more decisive in predicting the next year. This model, like most others, has be taken with a pinch of salt in the sense that generally past data is only one of the many factors defining future consequences for had that not been true, no unforeseen calamity would ever have struck mankind.