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Expectations Formation with Fat-Tailed Processes: Evidence and Theory

Author

Listed:
  • Tim de Silva
  • Eugene Larsen-Hallock
  • Adam Rej
  • David Thesmar

Abstract

This paper studies expectations formation when the underlying process has fat tails. Using a large sample of firm sales growth expectations, we document three facts: (i) the relationship between forecast revisions and future forecast errors is strongly non-linear, (ii) the distribution of sales growth has fat tails, and (iii) extreme values of sales growth tend to mean-revert. We formally show that these three facts are consistent with a model in which the underlying process is non-Gaussian, but forecasters fail to recognize this fully. We estimate this model and show it quantitatively explains our three facts. Finally, we show the model is consistent with evidence from an online forecasting experiment where the underlying process is non-Gaussian and the non-linearity in the momentum of stock returns.

Suggested Citation

  • Tim de Silva & Eugene Larsen-Hallock & Adam Rej & David Thesmar, 2025. "Expectations Formation with Fat-Tailed Processes: Evidence and Theory," NBER Working Papers 33808, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:33808
    Note: AP
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    More about this item

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets

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