Measurement Errors and Tests for Rationality

The traditional tests for rationality, the regression and volatility tests, have often rejected the hypothesis of rationality for survey data on expectations. It has been argued that these tests are not valid in the presence of unit roots and hence cointegration tests should be applied. The cointegration tests have often failed to reject the hypothesis of rationality. The present article argues that errors in variables affect tests of rationality. We use multiple sources of expectations to correct for the errors-in-variables bias but find that the hypothesis of rationality is rejected even after this correction. The article uses survey data on interest rates, stock prices, and exchange rates.