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Constrained Information Processing and Individual Income Expectations

Author

Listed:
  • Daniel Gutknecht

    (Mannheim University)

  • Stefan Hoderlein

    (Boston College)

  • Michael Peters

    (Yale University)

Abstract

Do individuals use all information at their disposal when forming expectations about future events? In this paper we present an econometric framework to answer this question. We show how individual information sets can be characterized by simple nonparametric exclusion restrictions and provide a quantile based test for constrained information processing. In particular, our methodology does not require individuals’ expectations to be rational, and we explicitly allow for individuals to have access to sources of information which the econometrician cannot observe. As an application, we use microdata on individual income expectations to study which information agents employ when forecasting future earnings. Consistent with models where information processing is limited, we find that individuals’ information sets are coarse in that valuable information is discarded. We then quantify the utility costs of coarse information within a standard consumption life-cycle model. Consumers would be willing to pay 0.04% of their permanent income to incorporate the econometrician’s information set in their forecasts.

Suggested Citation

  • Daniel Gutknecht & Stefan Hoderlein & Michael Peters, 2016. "Constrained Information Processing and Individual Income Expectations," Boston College Working Papers in Economics 898, Boston College Department of Economics.
  • Handle: RePEc:boc:bocoec:898
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    References listed on IDEAS

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