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 simulated, hypothetical data sets. The data sets are drawn at random from a distribution that satisfies some application-dependent content restrictions (such as that people prefer more money to less). Models that can fit almost all hypothetical data well are not restrictive.
To illustrate our approach, we evaluate the restrictiveness of two widely-used behavioral models, Cumulative Prospect Theory and the Poisson Cognitive Hierarchy Model, and explain how restrictiveness reveals new insights about them.

Keywords: model flexibility, experimental economics, behavioral economics

JEL Classification: C90, D90, C52