This paper develops generalized method‐of‐moments tests for the rationality of earnings per share forecasts made by individual stock analysts. We fail to reject the hypothesis of rationality as long as we take into account two complications: (1) the correlation in a given period of analysts' forecast errors in predicting earnings for firms in the same industry and (2) discretionary asset write‐downs, which affect earnings but are intentionally ignored by analysts when they make earnings forecasts. Our results challenge earlier work by De Bondt and Thaler and by Abarbanell and Bernard that found irrationality in analysts' forecasts.

One of the oldest questions in macroeconomics concerns the correlation between the business cycle and the real wage. We provide new evidence on this question by examining the possible bias that arises when (1) workers have unobserved characteristics that affect their wages and (2) those workers who move in and out of the work force over the cycle have unobserved characteristics systematically different from those who stay in. We distinguish as well between the bias that arises from those unobserved characteristics that are permanent components of wages and those that are transitory. We utilize micro, panel data, and maximum likelihood selectivity bias techniques to estimate both the extent of this selectivity-cum-aggregation bias and the true effect of the cycle on real wages. We find that selectivity bias is present: workers are more likely to lose employment during a recession if they have high wages, especially if they have a high transitory wage component. Overall, the effect of selectivity is to bias ordinary least squares estimates based only on workers in a procyclical direction. Our results show that the true effect of the cycle on wages is still procyclical but much smaller in magnitude than previous estimates using micro data have suggested.