What is the Adaptive Expectations Hypothesis?

Adaptive Expectations Hypothesis theory states that people adjust their expectations on what the future will be based on experiences and events of the recent past. 

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Rational Expectations

Adaptive expectation is closely related to rational expectations.

In rational expectations, an individual bases his or her expectations on three factors: available information, past experience, and human reasoning. 

 The main difference between adaptive expectations and rational expectation is that adaptive expectation uses real time data while rational expectation uses historical data. 

Adaptive Expectation Formula

A simple formula for applying adaptive expectation theory to expected inflation in an economy is: 

pe = pe-1+ (p-pe-1) 

Where: 

pe is next years inflation rate that is expected currently 

pe-1 is this years inflation rate that was expected the previous year 

p is this years actual rate of inflation is between 0 and 1 

Academics research on Adaptive Expectations Hypothesis

• Rational expectations and the theory of price movements, Muth, J. F. (1961). Rational expectations and the theory of price movements. Econometrica: Journal of the Econometric Society, 315-335. In order to explain fairly simply how expectations are formed, we advance the hypothesis that they are essentially the same as the predictions of the relevant economic theory. In particular, the hypothesis asserts that the economy generally does not waste information, and that expectations depend specifically on the structure of the entire system. Methods of analysis, which are appropriate under special conditions, are described in the context of an isolated market with a fixed production lag. The interpretative value of the hypothesis is illustrated by introducing commodity speculation into the system. 
• Rational and adaptive performance expectations in a customer satisfaction framework, Johnson, M. D., Anderson, E. W., & Fornell, C. (1995). Rational and adaptive performance expectations in a customer satisfaction framework. Journal of consumer research, 21(4), 695-707. This article develops and tests alternative models of market-level expectations, perceived product performance, and customer satisfaction. Market performance expectations are argued to be largely rational in nature yet adaptive to changing market conditions. Customer satisfaction is conceptualized as a cumulative construct that is affected by market expectations and performance perceptions in any given period and is affected by past satisfaction from period to period. An empirical study that supports adaptive market expectations and stable market satisfaction using data from the Swedish Customer Satisfaction Barometer is reported. 
• Rational versus adaptive expectations in present value models, Chow, G. C. (1991). Rational versus adaptive expectations in present value models. In Econometric Decision Models (pp. 269-284). Springer, Berlin, Heidelberg. Using data on stock price and dividends, and on long-term and short-term interest rates, we test an important implication of present value models, that current value is a linear function of the conditional expectations of the next-period value and the current determining variable. This implication, combined with rational expectations RE, is strongly rejected. Combined with adaptive expectations AE, it is accepted. The latter model can also explain the observed negative relation between the rate of return and stock price. Thus the RE assumption should be used with caution; the AE assumption may be useful in econometric practice. 
• Econometric implications of the rational expectations hypothesis, Wallis, K. F. (1980). Econometric implications of the rational expectations hypothesis. Econometrica: journal of the Econometric Society, 49-73. The implications for applied econometrics of the assumption that unobservable expectations are formed rationally in Muth's sense are examined. The statistical properties of the resulting models and their distributed lag and time series representations are described. Purely extrapolative forecasts of endogenous variables can be constructed, as alternatives to rational expectations, but are less efficient. Identification and estimation are considered: an order condition is that no more expectations variables than exogenous variables enter the model. Estimation is based on algorithms for nonlinear-in-parameters systems; other approaches are surveyed. Implications for economic policy and econometric policy evaluation are described. 
• A test of the" expectations hypothesis" using directly observed wage and price expectations, Turnovsky, S. J., & Wachter, M. L. (1972). A test of the" expectations hypothesis" using directly observed wage and price expectations. The Review of Economics and Statistics, 47-54.