Markov Switching Rationality
Abstract
The authors propose novel tests for the detection of Markov switching deviations from forecast rationality. Existing forecast rationality tests either focus on constant deviations from forecast rationality over the full sample or are constructed to detect smooth deviations based on non-parametric techniques. In contrast, these proposed tests are parametric and have an advantage in detecting abrupt departures from unbiasedness and efficiency, which are demonstrated with Monte Carlo simulations. Using the proposed tests, the authors investigate whether Blue Chip Financial Forecasts for the Federal Funds Rate are unbiased. These tests find evidence of a state-dependent bias: forecasters tend to systematically overpredict interest rates during periods of monetary easing, while the forecasts are unbiased otherwise. It was found that similar state-dependent bias is also present in market-based forecasts of interest rates, but not in the forecasts of real GDP growth and GDP deflator-based inflation. Results emphasize the special role played by monetary policy in shaping survey interest rate expectations above and beyond macroeconomic fundamentals.
Description
PublicFinanceSubject
Markov switchingforecast rationality
parametric
Monte Carlo simulations
Blue Chip Financial Forecasts
Federal Funds Rate
GDP
Collections
Citation
Sekhposyan, Tatevik; Odendah, Florensl; Rossi, Barbara (2022). Markov Switching Rationality. Private Enterprise Research Center, Texas A&M University; Texas A&M University. Library. Available electronically from https : / /hdl .handle .net /1969 .1 /199397.