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Expectation formation and regime switches

Published online by Cambridge University Press:  14 March 2025

Otwin Becker ,
Johannes Leitner  and
Ulrike Leopold-Wildburger
Otwin Becker
Affiliation:
Department of Statistics and Operations Research, Karl Franzens University, Universitätsstrasse 15/E3, 8010 Graz, Austria
Johannes Leitner
Affiliation:
Department of Statistics and Operations Research, Karl Franzens University, Universitätsstrasse 15/E3, 8010 Graz, Austria
Ulrike Leopold-Wildburger*
Affiliation:
Department of Statistics and Operations Research, Karl Franzens University, Universitätsstrasse 15/E3, 8010 Graz, Austria
*
e-mail: [email protected]
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Abstract

Economic agents often have to make decisions in environments affected by regime switches but expectation formation has hardly been explored in this context. We report about a laboratory experiment whose participants judgmentally forecast three time series subject to regime switches. The participants make forecasts without context knowledge and without support from statistical software. Their forecasts are only based on the previous realizations of the time series. Our interest is the explanation of the average forecasts with a simple model, the bounds & likelihood heuristic. In previous studies it was shown that this model can explain average forecasting behavior very well given stable and stationary time series. We find that the forecasts after a structural break are characterized by a higher variance and less accuracy over several periods. Considering this transition phase in the model, the heuristic performs even slightly better than the Rational Expectations Hypothesis.

Keywords

Structural changeJudgementCombined forecastsRational expectationsHeuristicsExperimental economics
Type
Research Article
Information
Experimental Economics , Volume 12 , Issue 3 , September 2009 , pp. 350 - 364
Copyright
Copyright © Economic Science Association 2009

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Footnotes

Electronic supplementary material The online version of this article (http://dx.doi.org/10.1007/s10683-009-9213-0) contains supplementary material, which is available to authorized users.

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