Rationalizing Rational Expectations? Tests and Deviations

63 Pages Posted: 16 Nov 2018 Last revised: 10 May 2019

See all articles by Xavier D'Haultfœuille

Xavier D'Haultfœuille

Center for Research in Economics and Statistics (CREST)

Christophe Gaillac

Center for Research in Economics and Statistics (CREST)

Arnaud Maurel

Duke University - Department of Economics; National Bureau of Economic Research (NBER); Institute for the Study of Labor (IZA)

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Date Written: November 12, 2018

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: Rational expectations; Test; Data combination; Subjective expectations; Sensitivity analysis

Suggested Citation

d'Haultfoeuille, Xavier and Gaillac, Christophe and Maurel, Arnaud, Rationalizing Rational Expectations? Tests and Deviations (November 12, 2018). Economic Research Initiatives at Duke (ERID) Working Paper No. 280, Available at SSRN: https://ssrn.com/abstract=3285357 or http://dx.doi.org/10.2139/ssrn.3285357

Xavier D'Haultfoeuille

Center for Research in Economics and Statistics (CREST) ( email )

5 avenue Henry le Chatelier
Palaiseau, 91120
France

Christophe Gaillac

Center for Research in Economics and Statistics (CREST) ( email )

15 Boulevard Gabriel Peri
Malakoff Cedex, 1 92245
France

Arnaud Maurel (Contact Author)

Duke University - Department of Economics ( email )

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Box 90097
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United States

National Bureau of Economic Research (NBER) ( email )

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Institute for the Study of Labor (IZA) ( email )

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Germany

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