Understanding Bias and Dispersion in Forecasts: The Role of Motivated Reasoning in the Idiosyncratic Interpretation of Public Information
Jeffrey W. Hales
The University of Texas at Austin
Abstract: Idiosyncratic interpretation of public information is playing an increasingly important role in theoretical models of investor behavior. Although these models now consider how idiosyncratic interpretations can affect the aggregate investor response to a public information release (by affecting the mean and variance of investor posteriors), they do little to describe when idiosyncratic interpretation is more likely to occur. This paper draws on psychological theory to predict two ways in which interpretations of public information will be affected when forecasters have financial stakes in the outcomes they are predicting: financial stakes will set the frame through which investors process information and investors will be more likely to interpret public information idiosyncratically when they view the information as unappealing. The experiment compares earnings per share predictions when forecastersÂ’ expected financial compensation depends on whether a firmÂ’s actual earnings exceed or fall beneath a reference point. The results show that public information generates relatively more disagreement and bias when it indicates that forecasters are likely to face a loss (rather than a gain) from their financial stakes. In addition to advancing our understanding of how motives affect judgments, these results suggest possible refinements to the way in which differential interpretation is modeled.
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