Chapter 14: Weak and Strong Individual Forecasts: Additional Experimental Evidence
Lucy F. Ackert, Bryan K. Church and Kirsten Ely INTRODUCTION Much research recognizes the importance of individual biases in market settings. Although finance theory traditionally assumes that market prices reflect available information, behavioral finance researchers have documented that individual psychology, including biased expectations, has an important role in understanding observed outcomes (Hirshleifer, 2001). Any bias in forecasts has the potential for significant impact on outcomes given the nature of forecasts as generated by individuals and their widespread use in capital markets. Individuals use forecasted information in making personal decisions and forecasts are critical inputs that direct the decisions of corporations. Professional financial analysts, in particular, are important intermediaries who provide information to investors and corporations. But, do analysts’ forecasts reflect their private information in an unbiased manner? In Trueman’s (1994) model, individual forecasts can rationally reflect forecaster bias. Ackert et al. (2008) provide evidence supportive of Trueman’s hypotheses in an experimental setting for one form of earnings distribution. However, earnings distributions vary widely across industries, between firms in the same industry and over time. One goal of the current study is to examine the robustness of the Ackert et al. (2008) (hereafter ACE) findings to a less disperse distribution, because companies have incentives to smooth earnings (e.g. Trueman and Titman, 1988; Arya et al., 2003). A second goal of the current study is to assess the usefulness of Trueman’s (1994) model as a guide to individual behavior when decisions are made in an alternative environment. While ACE’s findings are consistent...
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