Rationalizing Rational Expectations? Tests and Deviations

Xavier D'Haultfoeuille, Christophe Gaillac and Arnaud Maurel

No 11989, IZA Discussion Papers from Institute of Labor Economics (IZA)

Abstract: In this paper, we build a new test of rational expectations based on the marginal distributions of realizations and subjective beliefs. This test is widely applicable, including in the common situation where realizations and beliefs are observed in two different datasets that cannot be matched. We show that whether one can rationalize rational expectations is equivalent to the distribution of realizations being a mean-preserving spread of the distribution of beliefs. The null hypothesis can then be rewritten as a system of many moment inequality and equality constraints, for which tests have been recently developed in the literature. Next, we go beyond testing by defining and estimating the minimal deviations from rational expectations that can be rationalized by the data. In the context of structural models, we build on this concept to propose an easy-to-implement way to conduct a sensitivity analysis on the assumed form of expectations. Finally, we apply our framework to test for and quantify deviations from rational expectations about future earnings, and examine the consequences of such departures in the context of a life-cycle model of consumption.

Keywords: subjective expectations; data combination; test; rational expectations; sensitivity analysis (search for similar items in EconPapers)
JEL-codes: C12 D15 D84 (search for similar items in EconPapers)
Pages: 64 pages
Date: 2018-11
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

Published - published in: Quantitative Economics, 2021, 12 (3), 817 - 842

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Working Paper: Rationalizing Rational Expectations? Tests and Deviations (2018)
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