Expectation Formation with Correlated Variables

68 Pages Posted: 17 Sep 2019 Last revised: 13 Mar 2023

See all articles by Simin He

Simin He

Shanghai University of Finance and Economics - School of Economics

Simas Kucinskas

Humboldt University of Berlin

Date Written: March 12, 2023


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.

Keywords: Complexity, overreaction, underreaction, expectation formation

JEL Classification: C53, C93, D83, D84

Suggested Citation

He, Simin and Kucinskas, Simas, Expectation Formation with Correlated Variables (March 12, 2023). Available at SSRN: https://ssrn.com/abstract=3450207 or http://dx.doi.org/10.2139/ssrn.3450207

Simin He

Shanghai University of Finance and Economics - School of Economics ( email )

777 Guoding Road
Shanghai, 200433

Simas Kucinskas (Contact Author)

Humboldt University of Berlin

Dorotheenstrasse 1
Berlin, Berlin 10099

HOME PAGE: http://www.simaskucinskas.com

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