Rational Expectations Hypothesis: A Way of Reconciliation

John F. Muth wrote a paper entitled “Rational Expectations and the Theory of Price Movements,” which was published in 1961 This has been recognized as one of the most influential contributions to economics in the last few decades as it challenges the intellectual foundations of the traditional macroeconomic theories propounded by Keynesians as well as monetarists.

What is the central argument of the rational expectations hypothesis? In very simple terms it says that what matters in economics is not what actually happens but the difference between what actually happens and what was supposed or expected to happen.
Hence only the surprises in policy would have the kind of effects the policy maker is striving to achieve.

The implications of the rational expectation hypothesis for the dividend policy a firm are that: If the dividend announced is equal to what the market expected, there would be no change in the market price of the share, even if the dividend were higher (or
for that matter lower) than the previous dividend. The market, expecting the dividend to be higher, had discounted it. Put differently, the higher expectation was reflected in the market price already. Hence the announcement of the higher dividend would not have
any impact the market price.

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