Testing a New Hedging Theory of Prediction Interval Formation

26 Pages Posted: 1 Aug 2013 Last revised: 1 Feb 2014

See all articles by John Goddard

John Goddard

Bangor Business School

Qingwei Wang

Cardiff University - Cardiff Business School; ZEW – Leibniz Centre for European Economic Research

Date Written: July 31, 2013

Abstract

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 di fference 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

Goddard, John and Wang, Qingwei, Testing a New Hedging Theory of Prediction Interval Formation (July 31, 2013). Available at SSRN: https://ssrn.com/abstract=2304207 or http://dx.doi.org/10.2139/ssrn.2304207

John Goddard

Bangor Business School ( email )

Bangor Business School
College Road
Gwynedd LL57 2DG, Wales LL57 2DG
United Kingdom

Qingwei Wang (Contact Author)

Cardiff University - Cardiff Business School ( email )

Aberconway Building
Colum Drive
Cardiff, CF10 3EU
United Kingdom

ZEW – Leibniz Centre for European Economic Research ( email )

P.O. Box 10 34 43
L 7,1
D-68034 Mannheim, 68034
Germany

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