Biases in Macroeconomic Forecasts: Irrationality or Asymmetric Loss?
Empirical studies using survey data on expectations have frequently observed that forecasts are biased and have concluded that agents are not rational. We establish that existing rationality tests are not robust to even small deviations from symmetric loss and hence have little ability to tell whether the forecaster is irrational or the loss function is asymmetric. We quantify the trade-off between forecast inefficiency and asymmetric loss leading to identical outcomes of standard rationality tests and explore new and more general methods for testing forecast rationality jointly with flexible families of loss functions that embed squared loss as a special case. Empirical applications to survey data on forecasts of real output growth and inflation suggest that rejections of rationality may largely have been driven by the assumption of squared loss. Moreover, our results suggest that agents are averse to "bad" outcomes such as lower-than-expected real output growth and higher-than-expected inflation and that they incorporate such loss aversion into their forecasts. (JEL: C22, C53, E37) (c) 2008 by the European Economic Association.
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Volume (Year): 6 (2008)
Issue (Month): 1 (03)
|Contact details of provider:|| Web page: http://www.mitpressjournals.org/jeea|
|Order Information:||Web: http://www.mitpressjournals.org/jeea|
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Kenneth D. West, 1994.
"Asymptotic Inference About Predictive Ability,"
- Kenneth D. West & Michael W. McCracken, 1998.
"Regression-Based Tests of Predictive Ability,"
NBER Technical Working Papers
0226, National Bureau of Economic Research, Inc.
- Bonham, Carl & Cohen, Richard, 1995. "Testing the Rationality of Price Forecasts: Comment," American Economic Review, American Economic Association, vol. 85(1), pages 284-289, March.
- Elliott, Graham & Komunjer, Ivana & Timmermann, Allan G, 2003. "Estimating Loss Function Parameters," CEPR Discussion Papers 3821, C.E.P.R. Discussion Papers.
- Scharfstein, David. & Stein, Jeremy C., 1988.
"Herd behavior and investment,"
WP 2062-88., Massachusetts Institute of Technology (MIT), Sloan School of Management.
- Newey, Whitney K & West, Kenneth D, 1987.
"A Simple, Positive Semi-definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix,"
Econometric Society, vol. 55(3), pages 703-708, May.
- Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 33(1), pages 125-132.
- Whitney K. Newey & Kenneth D. West, 1986. "A Simple, Positive Semi-Definite, Heteroskedasticity and AutocorrelationConsistent Covariance Matrix," NBER Technical Working Papers 0055, National Bureau of Economic Research, Inc.
- Trueman, Brett, 1994. "Analyst Forecasts and Herding Behavior," Review of Financial Studies, Society for Financial Studies, vol. 7(1), pages 97-124.
- Tilman Ehrbeck & Robert Waldmann, 1996. "Why Are Professional Forecasters Biased? Agency versus Behavioral Explanations," The Quarterly Journal of Economics, Oxford University Press, vol. 111(1), pages 21-40.
- Frederic S. Mishkin, 1983.
"Are Market Forecasts Rational?,"
in: A Rational Expectations Approach to Macroeconomics: Testing Policy Ineffectiveness and Efficient-Markets Models, pages 59-75
National Bureau of Economic Research, Inc.
- Zarnowitz, Victor, 1985. "Rational Expectations and Macroeconomic Forecasts," Journal of Business & Economic Statistics, American Statistical Association, vol. 3(4), pages 293-311, October.
- A. Robert Nobay & David A. Peel, 1998. "Optimal Monetary Policy in a Model of Asymmetric Central Bank Preferences," FMG Discussion Papers dp306, Financial Markets Group.
- N. Gregory Mankiw & Ricardo Reis & Justin Wolfers, 2004.
"Disagreement about Inflation Expectations,"
in: NBER Macroeconomics Annual 2003, Volume 18, pages 209-270
National Bureau of Economic Research, Inc.
- N. Gregory Mankiw & Ricardo Augusto Marc Rocha Reis & Justin Wolfers, 2004. "Disagreement about Inflation Expectations," Yale School of Management Working Papers ysm391, Yale School of Management.
- N. Gregory Mankiw & Ricardo Reis & Justin Wolfers, 2003. "Disagreement about Inflation Expectations," NBER Working Papers 9796, National Bureau of Economic Research, Inc.
- Mankiw, N. Gregory & Reis, Ricardo & Wolfers, Justin, 2003. "Disagreement about Inflation Expectations," Research Papers 1807, Stanford University, Graduate School of Business.
- N. Gregory Mankiw & Ricardo Reis & Justin Wolfers, 2003. "Disagreement about Inflation Expectations," Harvard Institute of Economic Research Working Papers 2011, Harvard - Institute of Economic Research.
- Mc Cracken, Michael W., 2000. "Robust out-of-sample inference," Journal of Econometrics, Elsevier, vol. 99(2), pages 195-223, December.
- R. Mehra & E. Prescott, 2010.
"The equity premium: a puzzle,"
Levine's Working Paper Archive
1401, David K. Levine.
- Peter F. Christoffersen & Francis X. Diebold, 1994.
"Optimal Prediction Under Asymmetric Loss,"
NBER Technical Working Papers
0167, National Bureau of Economic Research, Inc.
- Peter F. Christoffersen & Francis X. Diebold, 1997. "Optimal prediction under asymmetric loss," Working Papers 97-11, Federal Reserve Bank of Philadelphia.
- Peter F. Christoffersen & Francis X. Diebold, "undated". "Optimal Prediction Under Asymmetric Loss," CARESS Working Papres 97-20, University of Pennsylvania Center for Analytic Research and Economics in the Social Sciences.
- Christoffersen & Diebold, "undated". "Optimal Prediction Under Asymmetric Loss," Home Pages 167, 1996., University of Pennsylvania.
- Owen Lamont, 1995.
"Macroeconomics Forecasts and Microeconomic Forecasters,"
NBER Working Papers
5284, National Bureau of Economic Research, Inc.
- Lamont, Owen A., 2002. "Macroeconomic forecasts and microeconomic forecasters," Journal of Economic Behavior & Organization, Elsevier, vol. 48(3), pages 265-280, July.
- Keane, Michael P & Runkle, David E, 1990. "Testing the Rationality of Price Forecasts: New Evidence from Panel Data," American Economic Review, American Economic Association, vol. 80(4), pages 714-735, September.
- Batchelor, Roy & Peel, David A., 1998. "Rationality testing under asymmetric loss," Economics Letters, Elsevier, vol. 61(1), pages 49-54, October.
- Jagjit Chadha & Philip Schellekens, 1998.
"Utility Functions For Central Bankers: The Not So Drastic Quadratic,"
FMG Discussion Papers
dp308, Financial Markets Group.
- Chadha, J.S. & Schellekens, P., 1998. "Utility functions for central bankers: the not so drastic quadratic," Discussion Paper Series In Economics And Econometrics 9818, Economics Division, School of Social Sciences, University of Southampton.
- John Conlisk, 1996. "Why Bounded Rationality?," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 669-700, June.
- Leitch, Gordon & Tanner, J Ernest, 1991. "Economic Forecast Evaluation: Profits versus the Conventional Error Measures," American Economic Review, American Economic Association, vol. 81(3), pages 580-590, June.
- Kajal Lahiri & Antony Davies & Xuguang Sheng, 2010. "Analyzing Three-Dimensional Panel Data of Forecasts," Discussion Papers 10-07, University at Albany, SUNY, Department of Economics.
- repec:cup:etheor:v:13:y:1997:i:6:p:808-17 is not listed on IDEAS
- Brown, Bryan W & Maital, Shlomo, 1981. "What Do Economists Know? An Empirical Study of Experts' Expectations," Econometrica, Econometric Society, vol. 49(2), pages 491-504, March.
- Davies, Anthony & Lahiri, Kajal, 1995. "A new framework for analyzing survey forecasts using three-dimensional panel data," Journal of Econometrics, Elsevier, vol. 68(1), pages 205-227, July.
- Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-1054, July.
- Zellner, Arnold, 1986. "Biased predictors, rationality and the evaluation of forecasts," Economics Letters, Elsevier, vol. 21(1), pages 45-48.
- Krane, Spencer D, 1994. "The Distinction between Inventory Holding and Stockout Costs: Implications for Target Inventories, Asymmetric Adjustment, and the Effect of Aggregation on Production Smoothing," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 35(1), pages 117-136, February.
- Fama, Eugene F, 1975. "Short-Term Interest Rates as Predictors of Inflation," American Economic Review, American Economic Association, vol. 65(3), pages 269-282, June.
- Batchelor, Roy & Dua, Pami, 1991. "Blue Chip Rationality Tests," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(4), pages 692-705, November.
When requesting a correction, please mention this item's handle: RePEc:tpr:jeurec:v:6:y:2008:i:1:p:122-157. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Kristin Waites)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.