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Biases In Macroeconomic Forecasts: Irrationality Or Asymmetric Loss?

  • Graham Elliott

    ()

  • Ivana Komunjer
  • Allan Timmermann

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 exact 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 quadratic loss as a special case. An empirical application to survey data on forecasts of nominal output growth demonstrates the empirical significance of our results and finds that rejections of rationality may largely have been driven by the assumption of symmetric loss.

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Paper provided by Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University in its series CAMA Working Papers with number 2005-14.

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Length: 35 pages
Date of creation: May 2005
Date of revision:
Handle: RePEc:een:camaaa:2005-14
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