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Marriott Marquis, Grand Ballroom 13
American Economic Association
Real Effects of Non-Rational Expectations
Saturday, Jan. 4, 2020 10:15 AM - 12:15 PM (PDT)
- Chair: David Thesmar, Massachusetts Institute of Technology
A Quantitative Analysis of Distortions in Managerial Forecasts
AbstractThis paper exploits a unique survey run by the Bank of Italy, matched with administrative data, to analyze managerial forecasts and their real economic consequences. Our representative panel of Italian firms contains both managerial sales forecasts as well as realizations, allowing us to measure forecast errors. We show that managerial forecast errors are positively and significantly autocorrelated. This persistence in forecast errors is consistent with managerial under-reaction to new information. Combined with the fact that forecasts are strongly related to investment, this suggests potential real effects of managerial under-reaction to news. To quantify the economic significance of this forecasting bias, we estimate a dynamic equilibrium model with heterogeneous firms and distorted expectations. In particular, we ask that the model matches forecast error autocorrelation and the link between investment and forecasts. Relative to a counterfactual with rational expectations, we find large biases and significant resulting distortions in firm-level investment. These investment distortions, however, imply much smaller loss in firm value of 0.6%. Also, in general equilibrium, investment distorsions generate negligible aggregate efficiency losses of about 0.1 %.
Credit Cycles and Corporate Investment
AbstractWe study the real effects of credit market sentiment on corporate investment and financing for a comprehensive panel of U.S. public and private firms over 1963-2016. In the short term, we find that high credit market sentiment in year t correlates with high corporate investment and debt issuance in year t + 1, particularly for financially constrained firms. In the longer term, high credit market sentiment in year t correlates with a decline in debt issuance in years t+3 and t+4; and with a decline in corporate investment in years t + 4 and t + 5. This pattern of increased investment in the short term and declined investment in the longer term is more pronounced for firms with larger analysts’ earnings forecast revisions and comes with larger analysts’ forecast errors, supporting theories of over-extrapolation of fundamentals into the future. A parsimonious dynamic model where over-extrapolation is the only departure from standard Q-theory does a good job matching the empirical moments of our data.
Real Credit Cycles
AbstractRecent empirical work has revived the Minsky hypothesis of boom-bust credit cycles driven by fluctuations in investor optimism. To quantitatively assess this hypothesis, we incorporate diagnostic expectations into an otherwise standard business cycle model with heterogeneous firms and risky debt. Diagnostic expectations are a psychologically founded, forward-looking model of belief formation that captures over-reaction to news. We calibrate the diagnosticity parameter using micro data on the forecast errors of managers of listed firms in the US. The model generates countercyclical credit spreads and default rates, while the rational version of the model generates the opposite pattern. Diagnostic expectations also offer a good fit of three patterns that have been empirically documented: 1) systematic reversals of credit spreads, 2) systematic reversals of aggregate investment, 3) predictability of future bond returns. Crucially, diagnostic expectations also generate: 4) strong fragility or sensitivity to small bad news after steady expansions. The rational version of the model can account for fact 1) but not for the others. Diagnostic expectations offer a parsimonious account of major credit cycles facts, underscoring the promise of realistic expectation formation for applied business cycle modeling.
University of Michigan
University of Texas-Austin
University of Oxford
University of Minnesota
- E7 - Macro-Based Behavioral Economics
- G4 - Behavioral Finance