Rationalizing rational expectations: Characterizations and tests

Journal Article (Academic article)

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 data sets that cannot be matched. We show that whether one can rationalize rational expectations is equivalent to the distribution of realizations being a meanā€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. The test is robust to measurement errors under some restrictions and can be extended to account for aggregate shocks. Finally, we apply our methodology to test for rational expectations about future earnings. While individuals tend to be right on average about their future earnings, our test strongly rejects rational expectations.

Full Text

Duke Authors

Cited Authors

  • D'Haultfoeuille, X; Gaillac, C; Maurel, A

Published Date

  • July 2021

Published In

Volume / Issue

  • 12 / 3

Start / End Page

  • 817 - 842

Published By

International Standard Serial Number (ISSN)

  • 1759-7323

Digital Object Identifier (DOI)

  • 10.3982/qe1724

Language

  • en