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A Test of the Rational Expectations Hypothesis using data from a Natural Experiment by

By Anna Conte, Peter G. Moffatt, Fabrizio Botti and Daniela T. Di Cagno

Abstract

Data on contestants ’ choices in Italian Game Show Affari Tuoi are analysed in a way that separates the effect of risk attitude from that of beliefs concerning the amount of money that will be offered to contestants in future rounds. The importance of belief-formation is confirmed by the estimation of a mixture model which establishes that the vast majority of contestants are forward-looking as opposed to myopic. The most important issue addressed in the paper is what belief function is actually being used by contestants. This function is estimated in an unconstrained way as a component of the choice model, which is estimated using maximum simulated likelihood. Separate identification of the belief function and preferences is possible by virtue of the fact that at a certain stage of the game, beliefs are not relevant, and risk attitude is the sole determinant of choice. The rational expectations hypothesis is tested by comparing the estimated belief function with the “true ” offer function which is estimated using data on offers actually made to contestants. We find that there is a significant difference between these two functions, and hence we reject the rational expectations hypothesis. However, when a simpler “rule-of-thumb ” structure is assumed for the belief function, we find a correspondence to th

Topics: rational expectations, risky choice
Year: 2007
OAI identifier: oai:CiteSeerX.psu:10.1.1.352.2282
Provided by: CiteSeerX
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