June 2023

A Comprehensive Empirical Evaluation of Biases in Expectation Formation

Kenneth Eva and Fabian Winkler

Abstract:

We revisit predictability of forecast errors in macroeconomic survey data, which is often taken as evidence of behavioral biases at odds with rational expectations. We argue that to reject rational expectations, one must be able to predict forecast errors out of sample. However, the regressions used in the literature often perform poorly out of sample. The models seem unstable and could not have helped to improve forecasts with access only to available information. We do find some notable exceptions to this finding, in particular mean bias in interest rate forecasts, that survive our out-of-sample tests. Our findings help narrow down the set of biases that merit closer attention of researchers in behavioral macroeconomics.

Keywords: Behavioral Bias, Forecasting, Out-of-sample prediction, Rational expectations, Survey Data

DOI: https://doi.org/10.17016/FEDS.2023.042

PDF: Full Paper

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Last Update: June 27, 2023