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A Test of the Rational Expectations Hypothesis using data from a Natural Experiment

Anna Conte (), Peter Moffatt (), Fabrizio Botti (), Daniela Di Cagno () and Carlo D'Ippoliti ()

No 2009-104, Jena Economic Research Papers from Friedrich-Schiller-University Jena

Abstract: Data on contestants' choices in Italian Game Show Affari Tuoi are analysed in a way that separates the effect of risk attitude (preferences) from that of beliefs concerning the amount of money that will be offered to contestants in future rounds. The most important issue addressed in the paper is what belief function is actually being used by contestants. The parameters of this function are estimated freely along with the parameters of a choice model. Separate identification of the belief function and preferences is possible by virtue of the fact that at a certain stage of the game, beliefs are not relevant, and risk attitude is the sole determinant of choice. The rational expectations hypothesis is tested by comparing the estimated belief function with the "true" offer function which is estimated using data on offers actually made to contestants. We find that there is a significant difference between these two functions, and hence we reject the rational expectations hypothesis. However, when a simpler "rule-of-thumb" structure is as- sumed for the belief function, we find a correspondence to the function obtained from data on actual offers. Our overall conclusion is that contestants are rational to the extent that they make use of all available relevant information, but are not fully rational because they are not processing the information in an optimal way. The importance of belief-formation is confirmed by the estimation of a mixture model which establishes that the vast majority of contestants are forward-looking as opposed to myopic.

Keywords: Beliefs; Discrete choice models; Method of simulated likelihood; Natural Experiments; rational expectations; risky choice (search for similar items in EconPapers)
JEL-codes: C15 C23 C25 D81 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cbe, nep-dcm and nep-upt
Date: 2009-12-21
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Journal Article: A test of the rational expectations hypothesis using data from a natural experiment (2012) Downloads
Working Paper: A Test of the Rational Expectations Hypothesis using data from a Natural Experiment (2011) Downloads
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