Markov Switching Rationality
Essays in Honor of Joon Y. Park: Econometric Methodology in Empirical Applications
ISBN: 978-1-83753-213-1, eISBN: 978-1-83753-212-4
Publication date: 24 April 2023
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, the proposed tests are parametric and have an advantage in detecting abrupt departures from unbiasedness and efficiency, which the authors demonstrate with Monte Carlo simulations. Using the proposed tests, the authors investigate whether Blue Chip Financial Forecasts (BCFF) for the Federal Funds Rate (FFR) are unbiased. The 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. The authors show that a 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. The results emphasize the special role played by monetary policy in shaping interest rate expectations above and beyond macroeconomic fundamentals.
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Acknowledgements
Acknowledgments
We thank the editor Yoosoon Chang and the three anonymous referees for their constructive comments and suggestions. Part of this research was carried out while Tatevik Sekhposyan was a Visiting Fellow at the Federal Reserve Bank of San Francisco, whose hospitality is gratefully acknowledged. The views expressed are those of the authors and do not necessarily reflect the views of the Banco de España, the Eurosystem, the Federal Reserve Bank of San Francisco or the Board of Governors of the Federal Reserve System. Barbara Rossi acknowledges Financial support from the Spanish Ministry of the Economy and Competitiveness and from the Spanish Agencia Estatal de Investigación (AEI), through the Severo Ochoa Programme for Centres of Excellence in R&D (Barcelona School of Economics CEX2019-000915-S) as well as the Spanish Ministry of Science and Innovation under grant PID2019-107352GB-100.
Citation
Odendahl, F., Rossi, B. and Sekhposyan, T. (2023), "Markov Switching Rationality", Chang, Y., Lee, S. and Miller, J.I. (Ed.) Essays in Honor of Joon Y. Park: Econometric Methodology in Empirical Applications (Advances in Econometrics, Vol. 45B), Emerald Publishing Limited, Leeds, pp. 35-64. https://doi.org/10.1108/S0731-90532023000045B002
Publisher
:Emerald Publishing Limited
Copyright © 2023 Florens Odendahl, Barbara Rossi and Tatevik Sekhposyan