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Anchoring bias in consensus forecasts and its effect on market prices

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Author Info
Sean D. Campbell
Steven A. Sharpe

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Abstract

Previous empirical studies that test for the "rationality" of economic and financial forecasts generally test for generic properties such as bias or autocorrelated errors, and provide limited insight into the behavior behind inefficient forecasts. In this paper we test for a specific behavioral bias -- the anchoring bias described by Tversky and Kahneman (1974). In particular, we examine whether expert consensus forecasts of monthly economic releases from Money Market Services surveys from 1990-2006 have a tendency to be systematically biased toward the value of previous months' data releases. We find broad-based and significant evidence for the anchoring hypothesis; consensus forecasts are biased towards the values of previous months' data releases, which in some cases results in sizable predictable forecast errors. Then, to investigate whether the market participants anticipate the bias, we examine the response of interest rates to economic news. We find that bond yields react only to the residual, or unpredictable, component of the surprise and not to the expected piece of the forecast error apparently induced by anchoring. This suggests market participants anticipate the anchoring bias embedded in expert forecasts.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2007-12.

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Date of creation: 2007
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Handle: RePEc:fip:fedgfe:2007-12

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Keywords: Economic forecasting ; Bond market;

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  1. Ottaviani, Marco & Sorensen, Peter Norman, 2006. "The strategy of professional forecasting," Journal of Financial Economics, Elsevier, vol. 81(2), pages 441-466, August. [Downloadable!] (restricted)
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  2. Aggarwal, Raj & Mohanty, Sunil & Song, Frank, 1995. "Are Survey Forecasts of Macroeconomic Variables Rational?," Journal of Business, University of Chicago Press, vol. 68(1), pages 99-119, January. [Downloadable!] (restricted)
  3. Refet S. Gürkaynak & Brian Sack & Eric Swanson, 2003. "The excess sensitivity of long-term interest rates: evidence and implications for macroeconomic models," Proceedings, Federal Reserve Bank of San Francisco, issue Mar. [Downloadable!]
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  4. Frederic S. Mishkin, 1981. "Are Market Forecasts Rational?," NBER Working Papers 0507, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. Newey, Whitney K., 1984. "A method of moments interpretation of sequential estimators," Economics Letters, Elsevier, vol. 14(2-3), pages 201-206. [Downloadable!] (restricted)
  6. Mullineaux, Donald J, 1978. "On Testing for Rationality: Another Look at the Livingston Price Expectations Data," Journal of Political Economy, University of Chicago Press, vol. 86(2), pages 329-36, April. [Downloadable!] (restricted)
  7. Andersen, Torben G. & Bollerslev, Tim & Diebold, Francis X. & Vega, Clara, 2002. "Micro Effects of Macro Announcements: Real-Time Price Discovery in Foreign Exchange," Working Papers 02-16, Duke University, Department of Economics. [Downloadable!]
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  8. Pierluigi Balduzzi & Edwin J. Elton & T. Clifton Green, 1997. "Economic News and the Yield Curve: Evidence from the U.S. Treasury Market," New York University, Leonard N. Stern School Finance Department Working Paper Seires 98-005, New York University, Leonard N. Stern School of Business-.
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  9. Frankel, Jeffrey A & Froot, Kenneth A, 1987. "Using Survey Data to Test Standard Propositions Regarding Exchange Rate Expectations," American Economic Review, American Economic Association, vol. 77(1), pages 133-53, March. [Downloadable!] (restricted)
  10. Refet S. Gürkaynak & Brian Sack & Eric Swanson, 2005. "The Sensitivity of Long-Term Interest Rates to Economic News: Evidence and Implications for Macroeconomic Models," American Economic Review, American Economic Association, vol. 95(1), pages 425-436, March. [Downloadable!]
  11. Jeffrey A. Frankel & Kenneth A. Froot, 1987. "Using Survey Data to Test Some Standard Propositions Regarding Exchange Rate Expectations," NBER Working Papers 1672, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  12. Ehrbeck, Tilman & Waldmann, Robert, 1996. "Why Are Professional Forecasters Biased? Agency versus Behavioral Explanations," The Quarterly Journal of Economics, MIT Press, vol. 111(1), pages 21-40, February. [Downloadable!] (restricted)
  13. Zarnowitz, Victor, 1985. "Rational Expectations and Macroeconomic Forecasts," Journal of Business & Economic Statistics, American Statistical Association, vol. 3(4), pages 293-311, October.
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