Credibility and Cheap Talk of Securities Analysts: Theory and Evidence

Abstract:     
This paper studies how investors react to public messages that may be optimistically biased. We first construct a communication game between an investor and a (possibly) biased securities analyst. We find an equilibrium characterised by the following properties: first, the investor reacts more to bad news than to good news, and second, the difference in this reaction is higher when the investor has a greater prior suspicion that the analyst is a biased type. We then use nonparametric techniques and a large database of earnings forecasts to test these predictions, and find that the evidence supports them. Lastly, we use our empirical strategy to discriminate between the causes for analysts' bias.

Number of Pages in PDF File: 44

Keywords: Cheap Talk, Credibility, Securities Analysts, Stock Market Reaction

JEL Classification: D82, G14, G24

working papers series