Constrained Information Processing and Individual Income Expectations

Daniel Gutknecht, Stefan Hoderlein and Michael Peters
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Daniel Gutknecht: Mannheim University
Stefan Hoderlein: Boston College, Postal: Dept. of Economics, Boston College, Chestnut Hill, MA 02467 USA
Michael Peters: Yale University
Authors registered in the RePEc Author Service: Halbert White

No 898, Boston College Working Papers in Economics from Boston College Department of Economics

Abstract: Do individuals use all information at their disposal when forming expectations about future events? In this paper we present an econometric framework to answer this question. We show how individual information sets can be characterized by simple nonparametric exclusion restrictions and provide a quantile based test for constrained information processing. In particular, our methodology does not require individuals’ expectations to be rational, and we explicitly allow for individuals to have access to sources of information which the econometrician cannot observe. As an application, we use microdata on individual income expectations to study which information agents employ when forecasting future earnings. Consistent with models where information processing is limited, we find that individuals’ information sets are coarse in that valuable information is discarded. We then quantify the utility costs of coarse information within a standard consumption life-cycle model. Consumers would be willing to pay 0.04% of their permanent income to incorporate the econometrician’s information set in their forecasts.

Date: 2016-02-01
New Economics Papers: this item is included in nep-upt
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