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Are internally consistent forecasts rational?

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posted on 2023-05-21, 08:04 authored by Jing TianJing Tian, Doko Tchatoka, F, Goodwin, T
Economic forecasts, such as the Survey of Professional Forecasters (SPF), are revised multiple times before realization of the target. This paper studies the sources of forecast revisions. By decomposing the fixed-event forecast error into a rational component due to unanticipated future shocks and an irrational component due to measurement error in acquired information or forecasters' reactions, we derive the conditions under which fixed-event forecasts that contain an irrational forecast error can still possess the second moment properties of rational forecasts. We show that internal consistency of fixed-event forecasts depends on the magnitude of the rational and irrational components in the revisions. As such, fixed-event forecasts subject to irrational error may still be internally consistent, although they are not rational, as evidence in many empirical studies. We illustrate our methodology with the SPF inflation forecasts data. Our results show evidence of a sizeable and heterogeneous irrational forecast error component across forecast horizons and a high irrational-to-news ratio for most forecasters. This finding also provides insight into why forecast revision effort is not always fully compensated by revision reward.

History

Publication title

Journal of Forecasting

Volume

41

Issue

7

Pagination

1338-1355

ISSN

0277-6693

Department/School

TSBE

Publisher

John Wiley & Sons Ltd

Place of publication

The Atrium, Southern Gate, Chichester, England, W Sussex, Po19 8Sq

Rights statement

© 2022. The Authors. Journal of Forecasting published by John Wiley & Sons Ltd. This article is distributed under the terms of the Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International (CC BY-NC-ND 4.0) License (https://creativecommons.org/licenses/by-nc-nd/4.0/) which permits non-commercial use, reproduction and distribution of the work without further permission provided the original work is attributed.

Repository Status

  • Open

Socio-economic Objectives

Macroeconomics not elsewhere classified

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