Abstract

http://ssrn.com/abstract=1065890
 
 

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Citations (38)



 


 



Effect of Analysts' Optimism on Estimates of the Expected Rate of Return Implied By Earnings Forecasts


Peter D. Easton


University of Notre Dame - Department of Accountancy

Gregory A. Sommers


Southern Methodist University (SMU) - Edwin L. Cox School of Business


Journal of Accounting Research, Vol. 45, No. 5, pp. 983-1015, December 2007

Abstract:     
Recent literature has used analysts' earnings forecasts, which are known to be optimistic, to estimate implied expected rates of return, yielding upwardly biased estimates. We estimate that the bias, computed as the difference between the estimates of the implied expected rate of return based on analysts' earnings forecasts and estimates based on current earnings realizations, is 2.84%. The importance of this bias is illustrated by the fact that several extant studies estimate an equity premium in the vicinity of 3%, which would be eliminated by the removal of the bias. We illustrate the point that cross-sample differences in the bias may lead to the erroneous conclusion that cost of capital differs across these samples by showing that analysts' optimism, and hence, bias in the implied estimates of the expected rate of return, differs with firm size and with analysts' recommendation. As an important aside, we show that the bias in a value-weighted estimate of the implied equity premium is 1.60% and that the unbiased value-weighted estimate of this premium is 4.43%.

Number of Pages in PDF File: 33

JEL Classification: G29, M41, G12

Accepted Paper Series


Date posted: December 11, 2007  

Suggested Citation

Easton, Peter D. and Sommers, Gregory A., Effect of Analysts' Optimism on Estimates of the Expected Rate of Return Implied By Earnings Forecasts. Journal of Accounting Research, Vol. 45, No. 5, pp. 983-1015, December 2007. Available at SSRN: http://ssrn.com/abstract=1065890 or http://dx.doi.org/10.1111/j.1475-679X.2007.00257.x

Contact Information

Peter D. Easton (Contact Author)
University of Notre Dame - Department of Accountancy ( email )
Mendoza College of Business
Notre Dame, IN 46556-5646
United States
574-631-6096 (Phone)
574-631-5127 (Fax)
Gregory A. Sommers
Southern Methodist University (SMU) - Edwin L. Cox School of Business ( email )
P.O. Box 750333
Dallas, TX 75275-0333
United States
214-768-1188 (Phone)
214-768-4099 (Fax)
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