Research output: Contribution to Journal/Magazine › Journal article › peer-review
Research output: Contribution to Journal/Magazine › Journal article › peer-review
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TY - JOUR
T1 - Asymmetric loss functions and the rationality of expected stock returns.
AU - Aretz, Kevin
AU - Bartram, Sohnke
AU - Pope, Peter
PY - 2011/4
Y1 - 2011/4
N2 - We combine the innovative approaches of Elliott, Komunjer, and Timmermann (2005) and Patton and Timmermann (2007) with a block bootstrap to analyze whether asymmetric loss functions can rationalize the S&P 500 return expectations of individual forecasters from the Livingston Surveys. Although the rationality of these forecasts has often been rejected, earlier studies have relied on the assumption that positive and negative forecast errors of identical magnitudes are equally important to forecasters. Allowing for homogenous asymmetric loss, our evidence still strongly rejects forecast rationality. However, if we allow for variation in asymmetric loss functions across forecasters, not only do we find significant differences in preferences, but also we can often no longer reject forecast rationality. Our conclusions raise serious doubts about the homogeneous expectations assumption often made in asset pricing, portfolio construction and corporate finance models.
AB - We combine the innovative approaches of Elliott, Komunjer, and Timmermann (2005) and Patton and Timmermann (2007) with a block bootstrap to analyze whether asymmetric loss functions can rationalize the S&P 500 return expectations of individual forecasters from the Livingston Surveys. Although the rationality of these forecasts has often been rejected, earlier studies have relied on the assumption that positive and negative forecast errors of identical magnitudes are equally important to forecasters. Allowing for homogenous asymmetric loss, our evidence still strongly rejects forecast rationality. However, if we allow for variation in asymmetric loss functions across forecasters, not only do we find significant differences in preferences, but also we can often no longer reject forecast rationality. Our conclusions raise serious doubts about the homogeneous expectations assumption often made in asset pricing, portfolio construction and corporate finance models.
KW - Financial markets
KW - General loss functions
KW - GMM block bootstrapping
KW - Livingston Survey
KW - Price forecasting
U2 - 10.1016/j.ijforecast.2009.10.008
DO - 10.1016/j.ijforecast.2009.10.008
M3 - Journal article
VL - 27
SP - 413
EP - 437
JO - International Journal of Forecasting
JF - International Journal of Forecasting
IS - 2
ER -