Analysts' Recommendations, Reputation and Noise Trading

Abstract:     
What dynamic strategies do market makers follow to cope with a sudden infusion of uninformed, buy-side price pressure that is sustained over many hours? The Wall Street Journal "Investment Dartboard" column provides a natural experiment for observing the behavior of market makers in such a context. Stock recommendations published in this column generate substantial increases in trading volume and temporary abnormal returns. Further, both abnormal returns and volume are associated with a naive measure of analyst reputation. Using intraday quotes we find that market makers react to the increases in trade by temporarily raising quotes above the fundamental values and by (slightly) increasing the amount of liquidity they provide in the market. Our findings are consistent with the view that market makers recognize that the Dartboard column generates a large, sustained increase in buying pressure from uninformed traders, and they conduct transactions in an optimal fashion from the outset.

JEL Classification: G1, G14

working papers series