New Experimental Evidence on Expectations Formation
Abstract
In this paper, we measure belief formation in an experimental setting where agents areincentivized to provide accurate forecasts of a random variable, drawn from a stable and
simple statistical process. Using these data, we estimate an empirical model that builds on the
recent literature on expectation dynamics: It nests rational expectations, but also allows for
extrapolation and under-reaction. Our findings are threefold. First, the rational expectation
hypothesis is strongly rejected in our setting, and we find little evidence or learning. Second,
both extrapolation and underreaction patterns are statistically discernible in the data, but
extrapolation quantitatively dominates. Third, our model coefficients are very robust to
changes in experimental setting: They do not depend on process parameters, individual
characteristics or framing. These large and stable deviations from rationality occur even
though the forecasting exercise is simple and transparent.