Expected Versus Realized Income Changes: A Test of the Rational Expectation Hypothesis
AbstractWe analyze answers to household survey questions on whether the respondents' household income has changed in the past twelve months, and on whether the respondents expect their household income to change in the next twelve months. Both questions are answered on a discrete five points scale.The data are an unbalanced panel of eleven consecutive annual waves.Using cross-tabulations of expected and realized changes, we first test the "best-case" hypothesis.This hypothesis implies, under two different nonparametric assumptions on how respondents form their predictions, that respondents have rational expectations, that there are no common unexpected shocks, and that reported expectations are best predictions of future outcomes.We find that the best case hypothesis is rejected: for all years, too many respondents who predict an income fall, ex post report that their household income has not changed.We then construct a bivariate ordered probit random effects panel data model, in which we explain both expectations and realizations from background variables such as age, education level, and labour market status, and from the one year lagged expectation and realization.We show that the hypothesis of rational expectations implies certain restrictions on the parameters in the two equations of this model.The model is estimated by simulated maximum likelihood using the Geweke-Hajivassilou-Keane (GHK) method.The hypothesis of rational expectations is rejected.The hypotheses that expectations are adaptive or naive can be tested in a similar way, and are also rejected.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 2000-105.
Date of creation: 2000
Date of revision:
Contact details of provider:
Web page: http://center.uvt.nl
household incomes; rational expectations; panel data; maximum likelihood; JEL classifications;
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Vassilis A. Hajivassiliou and Paul A. Ruud., 1993.
"Classical Estimation Methods for LDV Models Using Simulation,"
Economics Working Papers
93-219, University of California at Berkeley.
- Hajivassiliou, Vassilis A. & Ruud, Paul A., 1986. "Classical estimation methods for LDV models using simulation," Handbook of Econometrics, in: R. F. Engle & D. McFadden (ed.), Handbook of Econometrics, edition 1, volume 4, chapter 40, pages 2383-2441 Elsevier.
- Vassilis A. Hajivassiliou & Paul A. Ruud, 1993. "Classical Estimation Methods for LDV Models Using Simulation," Cowles Foundation Discussion Papers 1051, Cowles Foundation for Research in Economics, Yale University.
- Hajivassiliou, Vassilis A & Ruud, Paul A., 1993. "Classical Estimation Methods for LDV Models Using Simulation," Department of Economics, Working Paper Series qt3cg196fr, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
- V.A. Hajivassiliou & P. A. Ruud, 1993. "Classical Estimation Methods for LDV Models Using Simulation," Econometrics 9311002, EconWPA.
- Das, J.W.M. & Soest, A.H.O. van, 1995.
"Expected and realized income changes: Evidence from the Dutch socio-economic panel,"
1995-52, Tilburg University, Center for Economic Research.
- Das, Marcel & van Soest, Arthur, 1997. "Expected and realized income changes: Evidence from the Dutch socio-economic panel," Journal of Economic Behavior & Organization, Elsevier, vol. 32(1), pages 137-154, January.
- Das, J.W.M. & Soest, A.H.O. van, 1997. "Expected and realized income changes: Evidence from the Dutch socio-economic panel," Open Access publications from Tilburg University urn:nbn:nl:ui:12-121744, Tilburg University.
- repec:att:wimass:8905 is not listed on IDEAS
- Das, J.W.M. & Soest, A.H.O. van, 1996.
"A panel data model for subjective information on household income growth,"
Open Access publications from Tilburg University
urn:nbn:nl:ui:12-121740, Tilburg University.
- Das, Marcel & van Soest, Arthur, 1999. "A panel data model for subjective information on household income growth," Journal of Economic Behavior & Organization, Elsevier, vol. 40(4), pages 409-426, December.
- Das, J.W.M. & Soest, A.H.O. van, 1996. "A Panel Data Model for Subjective Information on Household Income Growth," Discussion Paper 1996-75, Tilburg University, Center for Economic Research.
- Guiso, Luigi & Jappelli, Tullio & Terlizzese, Daniele, 1996.
"Income Risk, Borrowing Constraints, and Portfolio Choice,"
American Economic Review,
American Economic Association, vol. 86(1), pages 158-72, March.
- Guiso, Luigi & Jappelli, Tullio & Terlizzese, Daniele, 1994. "Income Risk, Borrowing Constraints and Portfolio Choice," CEPR Discussion Papers 888, C.E.P.R. Discussion Papers.
- Alessie, Rob & Lusardi, Annamaria, 1997. "Saving and income smoothing: Evidence from panel data," European Economic Review, Elsevier, vol. 41(7), pages 1251-1279, July.
- Ivaldi, Marc, 1992. "Survey Evidence on the Rationality of Expectations," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 7(3), pages 225-41, July-Sept.
- Das, J.W.M. & Dominitz, J. & Soest, A.H.O. van, 1997.
"Comparing Predictions and Outcomes: Theory and Application to Income Changes,"
1997-45, Tilburg University, Center for Economic Research.
- Das, J.W.M. & Dominitz, J. & Soest, A.H.O. van, 1998. "Comparing predictions and outcomes: theory and application to income changes," Open Access publications from Tilburg University urn:nbn:nl:ui:12-121742, Tilburg University.
- Hugo Benitez-Silva & Debra S. Dwyer & Wayne-Roy Gayle & Tom Muench, 2005.
"Expectations in Micro Data: Rationality Revisited,"
Department of Economics Working Papers
05-04, Stony Brook University, Department of Economics.
- Benitez-Silva, Hugo & Dwyer, Debra S., 2006.
"Expectation formation of older married couples and the rational expectations hypothesis,"
Elsevier, vol. 13(2), pages 191-218, April.
- Hugo Benítez-Silva & Debra S. Dwyer, 2003. "Expectation Formation of Older Married Couples and the Rational Expectations Hypothesis," Working Papers wp062, University of Michigan, Michigan Retirement Research Center.
- R Alessie & A Kapteyn, 2001. "New data for understanding saving," Oxford Review of Economic Policy, Oxford University Press, vol. 17(1), pages 55-69, Spring.
- Mauro Mastrogiacomo, 2006. "Testing consumers' asymmetric reaction to wealth changes," CPB Discussion Paper 53, CPB Netherlands Bureau for Economic Policy Analysis.
- Xavi Ramos & Christian Schluter, 2003. "Subjective Income Expectations, Canonical Models and Income Risk," Working Papers wpdea0310, Department of Applied Economics at Universitat Autonoma of Barcelona.
- Ramos, Xavi & Schluter, Christian, 2006. "Subjective Income Expectations and Income Risk," IZA Discussion Papers 1950, Institute for the Study of Labor (IZA).
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Richard Broekman).
If references are entirely missing, you can add them using this form.