Working Paper: CEPR ID: DP12898
Authors: Tobias Broer; Alexandre Kohlhas
Abstract: Professional forecasts are often used to gauge the expectations of households and firms. Recently, the average of such forecasts have been argued to support rational expectation formation with noisy private information. We document that individual forecasts of US GDP and inflation in the Survey of Professional Forecasters overrespond to both private and public information, contradicting, prima facie, the assumption of noisy rational expectation formation. We generalize two alternative models of forecaster behavior that focus on strategic diversification and behavioral overconfidence, respectively, to dynamic environments with noisy private information. We find that both models predict overresponses, but only the overconfidence model is simultaneously consistent with a substantial overreaction to public information.
Keywords: Forecaster Behavior; Rational Expectations; Bounded Rationality
JEL Codes: C53; D83; D84
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| overconfidence model predicts overreaction to private signals (G41) | individual forecasts of US GDP and inflation (E37) |
| overconfidence model predicts overreaction to public signals (G41) | individual forecasts of US GDP and inflation (E37) |
| strategic diversification model predicts overreaction to private signals (G41) | individual forecasts of US GDP and inflation (E37) |
| individual forecasts of US GDP and inflation are influenced by behavioral biases (E71) | individual forecasts of US GDP and inflation (E37) |
| CPI forecasts are less responsive than those for GDP (E31) | individual forecasts of US GDP and inflation (E37) |
| individual forecasts of US GDP and inflation overreact to private information (D89) | magnitude of forecast revisions (C53) |
| individual forecasts of US GDP and inflation overreact to public information (E27) | magnitude of forecast revisions (C53) |
| forecast errors are significantly correlated with past forecast revisions (C53) | individual forecasts of US GDP and inflation (E37) |
| forecast errors are significantly correlated with consensus forecasts (C53) | individual forecasts of US GDP and inflation (E37) |