Overreaction Through Expectation Smoothing

Abstract

We document that updates to macroeconomic expectations among professional forecasters are (i) negatively serially correlated at the individual level, (ii) positively serially correlated at the aggregate level, and (iii) exhibit an offsetting pattern. To explain these facts, we build and estimate a model featuring annual smoothing and a requirement that quarterly predictions be jointly consistent with the annual forecast. Relative to existing theories, our model provides a unified explanation for the three facts as well as other forms of over and underadjustment. Furthermore, our model suggests that annual forecasts exhibit more information rigidity than quarterly forecasts, with a larger role for sticky information relative to noisy information.

Publication
Working Paper