Expectation Formation with Correlated Variables

Simin He and Simas Kučinskas

The Economic Journal, 2024, vol. 134, issue 660, 1517-1544

Abstract: We experimentally study how people form expectations about correlated variables. Subjects forecast a time-series variable A. In treatment Baseline, subjects only observe past values of A. In treatment Correlated, they additionally observe a correlated variable B; A is equally predictable and has the same univariate properties in both treatments. Subjects are significantly less accurate and underreact more in Correlated, inconsistent with Bayesian learning. A structural-model estimation indicates that subjects (i) underestimate the level of correlation and (ii) are insensitive to actual correlation. Our study provides first direct evidence of correlation neglect in the domain of expectation formation.

Date: 2024
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