Expectations Formation with Fat-tailed Processes: Evidence from Sales Forecasts

2022/10/18 by Larsen-Hallock, Eugene, Rej, Adam, Thesmar, David
#FOS: Economics and business #General Finance (q-fin.GN) #Statistical Finance (q-fin.ST)

paper · doi:10.48550/arxiv.2210.10169

Abstract

We empirically analyze a large sample of firm sales growth expectations. We find that the relationship between forecast errors and lagged revision is non-linear. Forecasters underreact to typical (positive or negative) news about future sales, but overreact to very significant news. To account for this non-linearity, we propose a simple framework, where (1) sales growth dynamics have a fat-tailed high frequency component and (2) forecasters use a simple linear rule. This framework qualitatively fits several additional features of data on sales growth dynamics, forecast errors, and stock returns.

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