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How Well Do Individuals Predict Their Future Life Satisfaction? Rationality and Learning Following a Nationwide Exogenous Shock

  • Paul Frijters
  • John P. Haisken-DeNew
  • Michael Shields

Over recent years a number of papers have uses individual or household longitudinal survey data to investigate the rationality of income expectations. In this paper we provide a novel contribution to this literature by examining the ability of individuals to correctly predict their own future life satisfaction using longitudinal data for East Germans. The environment in which this analysis is based is the decade following reunification of Germany, and it is generally accepted that reunification was completely unexpected and delivered a particularly large shock to the future prospects of the inhabitants of the former East Germany. We therefore take it as a 'natural' experiment through which to study the rationality of expectations and the adjustment of expectations over a period of substantial transition. Our results show that the majority of East Germans significantly over-estimated the gains from reunification. As with the recent literature on income expectations, we find strong evidence of micro-heterogeneity with the largest prediction errors being for the young, the poorly educated and those with children. An important result, however is that expectations and realisations of life satisfaction in East Germany had essentially converged only five years after reunification, at a level considerably below that of West Germans.

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File URL: https://www.cbe.anu.edu.au/researchpapers/cepr/DP468.pdf
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Paper provided by Centre for Economic Policy Research, Research School of Economics, Australian National University in its series CEPR Discussion Papers with number 468.

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Length: 25 pages
Date of creation: Sep 2003
Date of revision:
Handle: RePEc:auu:dpaper:468
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