Abstract

http://ssrn.com/abstract=1543309
 
 

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Reading the Tea Leaves: Model Uncertainty, Robust Forecasts, and the Autocorrelation of Analysts' Forecast Errors


Juhani T. Linnainmaa


University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

Walter N. Torous


University of California, Los Angeles (UCLA) - Finance Area

James S. Yae


University of Houston - C.T. Bauer College of Business

May 6, 2015

Chicago Booth Research Paper No. 10-04
CRSP Working Paper

Abstract:     
We put forward a model in which analysts are uncertain about a firm's earnings process. Faced with the possibility of using a misspecified model, analysts issue forecasts that are robust to model misspecification. We estimate that this mechanism explains approximately 60% of the observed autocorrelation in analysts' forecast errors. The remainder of the observed autocorrelation stems from the cross-sectional variation in mean forecast errors and analysts' estimation errors of the persistence of earnings growth shocks. Consistent with our model, we find that analysts learn about some features of the earnings process but not others, and this learning reduces, but does not eliminate, the autocorrelation of forecast errors as firms age. Other potential explanations for the observed autocorrelation of analyst's forecast errors are rejected. Our model of robust forecasting applies not only to analysts' forecasts but to all model-based forecasts.

Number of Pages in PDF File: 53

Keywords: Model uncertainty, parameter uncertainty, learning, robustness, financial analysts

JEL Classification: G14, G24


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Date posted: January 28, 2010 ; Last revised: May 7, 2015

Suggested Citation

Linnainmaa, Juhani T. and Torous, Walter N. and Yae, James S., Reading the Tea Leaves: Model Uncertainty, Robust Forecasts, and the Autocorrelation of Analysts' Forecast Errors (May 6, 2015). Chicago Booth Research Paper No. 10-04; CRSP Working Paper. Available at SSRN: http://ssrn.com/abstract=1543309 or http://dx.doi.org/10.2139/ssrn.1543309

Contact Information

Juhani T. Linnainmaa (Contact Author)
University of Chicago - Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
(773) 834-3176 (Phone)
(773) 753-1052 (Fax)
HOME PAGE: http://faculty.chicagobooth.edu/juhani.linnainmaa
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Walter N. Torous
University of California, Los Angeles (UCLA) - Finance Area ( email )
Los Angeles, CA 90095-1481
United States
310-825-4059 (Phone)
310-206-5455 (Fax)
James S. Yae
University of Houston - C.T. Bauer College of Business ( email )
Houston, TX 77204-6021
United States
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