How Flexible is that Functional Form? Quantifying the Restrictiveness of Theories

Abstract

We propose a new way to quantify the restrictiveness of an economic model, based on how well the model fits synthetic data from a pre-defined class. The restrictiveness measure, together with a measure for how well the model fits real data, outlines a Pareto frontier, where models that rule out more regularities, yet capture the regularities that are present in real data, are preferred. To illustrate our approach, we evaluate the restrictiveness of popular models in two laboratory settings - certainty equivalents and initial play - and in one field setting -takeup of micro finance in Indian villages. The restrictiveness measure reveals new insights about each of the models, including that some economic models with only a few free parameters are very flexible.

Keywords: model flexibility, experimental economics, behavioral economics

JEL Classification: C90, D90, C52