Businessmen's Expectations Are Neither Rational nor Adaptive

A framework which allows for the joint testing of the adaptive and rational expectations hypotheses is presented. We assume joint normality of expectations, realizations and variables in the information set, allowing for parsimonious interpretation of the data; conditional first moments are linear in the conditioning variables, and we can easily recover regression coefficients from them and test simple hypotheses by imposing zero restrictions on these coefficients. The nature of the data, which are responses to business surveys and are all categorical, requires simulation techniques to obtain full information maximum likelihood estimates. We use a latent variable model which allows for the construction of a simple likelihood function. However, this likelihood contains multi-(four)dimensional integrals, requiring simulators to evaluate. Simulated maximum-likelihood estimation is carried out using the Geweke-Hajivassilou-Keane (GHK) method, which is consistent and has low variance. The latter is crucial when maximizing the log-likelihood directly. Identification of the parameters is achieved by placing restrictions on the response thresholds and/or the variances. We find that we can reject both hypotheses.