Company Expectations and New Information: An Application of Kalman Filtering

Kalman filtering is used as a method of analysing the expectation formulation procedures employed by companies. The filter permits a number of alternative representations of managers' models of their firms activities to be compared. Applying the procedure to United Kingdom data on expectations, straightforward representations are found to provide reasonable descriptions of company predictions that frequently outperform contending hypotheses. However, there is evidence of changes in the forecasting rules employed and indications that multi-model versions of the filter provide better descriptions. A very straightforward forecasting rule that in some cases outperforms companies' own expectations is also revealed.