Essays on forecasting and latent values

It is common practice to evaluate fixed-event forecast revisions in macroeconomics by regressing current forecast revisions on one-period lagged forecast revisions. Under weakform (forecast) efficiency, the correlation between the current and one-period lagged revisions should be zero. The empirical findings in the literature suggest that the null hypothesis of zero correlation between the current and one-period lagged revisions is rejected frequently, where the correlation can be either positive (which is widely interpreted in the literature as “smoothing”) or negative (which is widely interpreted as “over-reacting”). In this chapter we propose a methodology to be able to interpret such non-zero correlations in a straightforward and clear manner. Our approach is based on the assumption that numerical forecasts can be decomposed into both an econometric model and random expert intuition. We show that the interpretation of the sign of the correlation between the current and one-period lagged revisions depends on the process governing intuition, and the current and lagged correlations between intuition and news (or shocks to the numerical forecasts). It follows that the estimated non-zero correlation cannot be given a direct interpretation in terms of smoothing or over-reaction. It is also shown that smoothing and over-reaction, modelled and interpreted correctly, can change over time. An empirical example is given to highlight the usefulness of the proposed methodology. 8 Analyzing fixed-event forecast revisions