Rationality testing under asymmetric loss

This paper shows that if agents have an asymmetric loss function, standard empirical tests for the rationality of their expectations are in general invalid. We further show that under a popular class of asymmetric loss functions, the linex family, a valid test can be carried out by estimating an appropriate ARCH-in-Mean model. The contrast between the standard test and our ARCH-M test is illustrated using the Goldsmith–Nagan forecasts of US Treasury bill yields.