FRU Finance Research Unit The Strategy of Professional Forecasting

This paper develops and compares two theories of strategic behavior of profes-sional forecasters. The first theory posits that forecasters compete in a forecasting contest with pre-specified rules. In equilibrium of a winner-take-all contest, forecasts are excessively differentiated. According to the alternative reputational cheap talk theory, forecasters aim at convincing the market that they are well informed. The market evaluates their forecasting talent on the basis of the forecasts and the real-ized state. If the market expects forecaster honesty, forecasts are shaded toward the prior mean. With correct market expectations, equilibrium forecasts are imprecis