Testing a New Hedging Theory of Prediction Interval Formation
26 Pages Posted: 1 Aug 2013 Last revised: 1 Feb 2014
Date Written: July 31, 2013
We develop and test a simple hedging theory of prediction interval formation. In the presence of uncertainty, forecasters hedge their forecasts by adjusting the prediction interval based on their own (first-order) belief in a way that reflects their (second-order) belief about others’ beliefs. Anchoring and adjustment leads to a positive relationship between an asymmetry measure for the prediction interval and the belief wedge, defined as the difference between the second-order belief and the first-order belief. Using data from three experiments in which subjects are asked to forecast future stock prices, we provide empirical support for the theory.
Keywords: Confidence intervals, Second-order beliefs, Skewness, Forecasts, Decision under uncertainty
JEL Classification: C91, G02, G17
Suggested Citation: Suggested Citation