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TURNING ACADEMIC INSIGHT INTO INVESTMENT PERFORMANCE®
Avoid the Experts: A Lesson in CFO Overconfidence
(//www.alphaarchitect.com/blog/2014/12/05/avoid-theexperts-a-lesson-in-cfo-overconfidence/)
 Wesley R. Gray, Ph.D. (//www.alphaarchitect.com/author/4/)

QVAL: $19.99!
 12/05/2014 10:05
30
Managerial Miscalibration
Ben-David, Graham and Harvey
A version of the paper can be found here (http://papers.ssrn.com/sol3/papers.cfm?
abstract_id=1640552).
Want a summary of academic papers with alpha? Check out our Academic
Research Recap Category (http://www.alphaarchitect.com/category/academicresearch/).
Abstract:
“
Using a unique 10-year panel that includes more than 13,300 expected
stock market return probability distributions, we find that executives
are severely miscalibrated, producing distributions that are too narrow:
realized market returns are within the executives’ 80% confidence
intervals only 36% of the time. We show that executives reduce the
lower bound of the forecast confidence interval during times of high
market uncertainty; however, ex post miscalibration is worst during
periods of high uncertainty. We also find that executives who are
miscalibrated about the stock market show similar miscalibration
regarding their own firms’ prospects. Finally, firms with miscalibrated
executives seem to follow more aggressive corporate policies: investing
more and using more debt financing.
(http://www.amazon.com/gp/product/1118328078/ref=as_li_tl?
ie=UTF8&camp=1789&creative=390957&creativeASIN=1118328078&linkCode=as2&tag=welcomtothead20&linkId=U7BGXMK6B4I7XCGQ)
New Inventory on Deck. $19.99 While
Supplies Last Order Now.
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ie=UTF8&camp=1789&creative=390957&creativeASIN=1118328078&linkCode=as2&tag=welcomtothead20&linkId=U7BGXMK6B4I7XCGQ)
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"Miscalibration" is defined as excessive confidence about having accurate information
(Alpert and Raiffa, 1982).
papers/)
(//www.alphaarchitect.com/category/white-

This paper conducted quarterly surveys on finance professionals, most of whom are
CFOs of mid-size and large US firms. This research covered a 10 year stretch (June 2001March 2011) and historical surveys/responses can be found at http://www.cfosurvey.org/
(http://www.cfosurvey.org/).
The basic question on the survey is below:
Over the next year, I expect the annual S&P 500 return will be:
There is a 1-in-10 chance the actual return will be less than ___%
I expect the return to be: ___%
There is a 1-in-10 chance the actual return will be greater than ___%
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The second question is similar, but initial words change to "Over the next 10 years, I
expect the average annual S&P 500 return will be.” So the first question asks about shortterm return prediction and the second question targets long-term return prediction.
selection-research/)
The authors deliberately gather upper bound (90th) and lower bound (10th) answers and
do not require participants to provide symmetric confidence intervals. We can interpret
wider confidence intervals as higher subjective uncertainty about estimation; while we
behavioral-finance/)

Behavioral Finance Research
(//www.alphaarchitect.com/category/turnkey-

Education
wider confidence intervals as higher subjective uncertainty about estimation; while we
can interpret narrower confidence intervals as higher subjective confidence about
estimation. If CFOs were well calibrated, their 80% confidence intervals would include the
correct answer 80% of the time. Over the 10 years, the authors collected 13,300 CFO
forecasts of the S&P 500 from the surveys.
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Key Findings:
Return Forecasts: CFOs are severely miscalibrated. The realized one-year S&P 500 returns
are within the CFOs' 80% confidence intervals only 36.3% of the time! Even during the
least volatile quarter, this number is just 59%.
CFOs appear somewhat less miscalibrated when making long-term forecasts.

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Our Academic Research
Wesley R. Gray, PhD.
(http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?
per_id=432318)

Jack R. Vogel, PhD.
(http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?
per_id=1762423)

Hui Chen, PhD.
(http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?
per_id=489075)
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Steven Crawford, PhD.
(http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?
per_id=335884)

Richard A. Price, PhD.
(http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?
per_id=334416)

Gil Sadka, PhD.
(http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?
per_id=361934)
(http://blog.alphaarchitect.com/wp-content/uploads/2014/11/2014-11-18-17_40_39-AddNew-Post-‹-Alpha-Architect-—-WordPress.png)

Disclosures
The results are hypothetical results and are NOT an indicator of future results and do NOT represent
returns that any investor actually attained. Indexes are unmanaged, do not reflect management or
trading fees, and one cannot invest directly in an index. Additional information regarding the
construction of these results is available upon request.
Performance figures contained herein are
hypothetical, unaudited and prepared by
Alpha Architect, LLC; hypothetical results are
intended for illustrative purposes only. Past
performance is not indicative of future
Volatility Forecasts: The paper also calculates CFOs' individual volatility estimates and
distribution, then compare it to the historical volatility distribution. The figure below
shows that CFOs' one-year imputed volatilities center at 4%, while historical volatility
centers at 12%. 58% of the CFOs' imputed individual volatilities are lower than 5.1% --- an
extraordinarily low estimate given the historical data.
Ten-year (long-term) volatility forecasts are also miscalibrated, but to a lesser degree.
(http://blog.alphaarchitect.com/wp-content/uploads/2014/11/2014-11-18-17_39_03Managerial-Miscalibration.pdf-Adobe-Reader.png)
Imputed individual volatility formula: For confidence intervals of 80% in a normal distribution, Z equals
2.65.
results, which may vary. There is a risk of
substantial loss associated with trading
stocks, commodities, futures, options and
other financial instruments. Please click "Full
Disclaimer" for additional disclosures.
FULL DISCLOSURES
(http://blog.alphaarchitect.com/wp-content/uploads/2014/11/2014-11-18-16_41_04Managerial-Miscalibration.pdf-Adobe-Reader1.png)
The results are hypothetical results and are NOT an indicator of future results and do NOT represent
returns that any investor actually attained. Indexes are unmanaged, do not reflect management or
trading fees, and one cannot invest directly in an index. Additional information regarding the
construction of these results is available upon request.
More findings:
CFOs in the survey are overconfident.
CFOs who are miscalibrated about the stock market show similar miscalibration
regarding their own firms’ corporate planning and forecasting (such as projects' IRR
forecasts).
More miscalibrated managers invest more and tolerate higher leverage.
***
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***
Alpha Architect believes in a systematic, evidence-based, and fully transparent approach to
asset-management. Please contact us (http://www.alphaarchitect.com/about#tabs-3a) to
learn more
(//www.alphaarchitect.com/author/4/)
WESLEY R. GRAY, PH.D. (//WWW.ALPHAARCHITECT.COM/AUTHOR/4/)
Dr. Gray has been an active participant in financial markets for over 15 years. His
experience includes positions as a Captain in the United States Marine Corps, as a
finance professor at Drexel University, and as a portfolio manager for a specialsituations hedge fund. Education and entrepreneurship has been the focus of his
professional endeavors and his research interests are focused on the performance of
portfolio managers and behavioral finance. Dr. Gray is currently the Executive
Managing Member of Alpha Architect, an SEC-Registered Investment Advisor. Dr.
Gray has published two books: EMBEDDED: A Marine Corps Adviser Inside the Iraqi
Army and QUANTITATIVE VALUE: A Practitioner’s Guide to Automating Intelligent
Investment and Eliminating Behavioral Errors. His work has been highlighted on CNN,
NPR, Motley Fool, WSJ Market Watch, CFA Institute, Institutional Investor, and CBS
News. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago
and graduated magna cum laude with a BS from The Wharton School of the
University of Pennsylvania.
View other articles from this author (//www.alphaarchitect.com/author/4/)

(//www.alphaarchitect.com/blog/2014/12/04/amodification-of-flexible-asset-allocation/)

(//www.alphaarchitect.com/blog/2014/12/08/whereare-the-focused-managers/)
A MODIFICATION TO THE FLEXIBLE
WHERE ARE THE FOCUSED ACTIVE
ASSET ALLOCATION MODEL
MANAGERS?
(//WWW.ALPHAARCHITECT.COM/BLOG/2014/12/04/A(//WWW.ALPHAARCHITECT.COM/BLOG/2014/12/08/WHEREMODIFICATION-OF-FLEXIBLEARE-THE-FOCUSED-MANAGERS/)
 WESLEY R. GRAY, PH.D.
ASSET-ALLOCATION/)
 ILYA KIPNIS
(//WWW.ALPHAARCHITECT.COM/AUTHOR/11332/) 
12/04/2014 11:01
(//WWW.ALPHAARCHITECT.COM/AUTHOR/4/)  12/08/2014
10:15
We highlighted a few weeks ago that Smart
Ilya Kipnis is the author of QuantStrat
Beta is More Expensive Than You Think.
TradeR. We like the work he does on his blog
Smart Beta and other closet-indexers are
and his willingness to share his source code
everywhere, but what happened to old-
on various algorithms with the public. We
fashioned high-conviction active manag ...
asked Ilya if he'd be intere ...
CONITINUE READING
CONITINUE READING
(//WWW.ALPHAARCHITECT.COM/BLOG/2014/12/08/WHERE-
(//WWW.ALPHAARCHITECT.COM/BLOG/2014/12/04/A-
ARE-THE-FOCUSED-MANAGERS/)
MODIFICATION-OF-FLEXIBLE-ASSET-ALLOCATION/)
2 Comments
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Michael Milburn • 2 months ago
Should we expect CFOs to be very good at predicting S&P500 returns? The info about
overconfidence about their own company tends to fit the research showing that having extra
info makes us overconfident without improving accuracy.
△ ▽
• Reply • Share › TheBigDog Barks • 2 months ago
It ain't what you don't know that gets you into trouble. It's what you know for sure that just
ain't so.
Mark Twain
△ ▽
• Reply • Share › WHAT'S THIS?
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