Working Paper: CEPR ID: DP17813
Authors: Pamela Giustinelli; Stefano Rossi
Abstract: We develop a theory of forecast coherence in a firm production setting, which yields a normative ex ante benchmark of first-best coherent forecasts and statistical tests to detect incoherence ex post. Under the null, the forecast errors of output and inputs are "close" to one another. Using the Duke Survey of top executives of large US corporations, we reject the null of coherence for 55% of CFOs in our sample. In a positive version of our model, incoherence reflects intra-personal frictions in coordinating multiple forecasts, implying that some of the rules of thumb proposed by the managerial education literature to make contemporaneous forecasts may emerge as second-best optimal. Consistent with our model, we find that corporate performance correlates negatively with incoherence, being lowest for firms whose CFOs provide "narrow bracketing" forecasts---projecting past capital growth into the future while ignoring output and labor. We also find that the use of incoherent rules of thumb correlates negatively with corporate investment spending and positively with corporate leverage.
Keywords: coherence; rules of thumb; narrow bracketing; firm expectations
JEL Codes: D84; D22; L2; M2; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| incoherence in forecasts (C53) | corporate performance (G38) |
| narrow bracketing forecasts (F37) | corporate performance (G38) |
| incoherent rules of thumb (D80) | corporate investment spending (G31) |
| incoherent rules of thumb (D80) | corporate leverage (G32) |
| forecast errors in input growth (O47) | forecast errors in output growth (O40) |
| coherent forecasts (C53) | corporate performance (G38) |