Rating on a Behavioral Curve
59 Pages Posted: 21 Nov 2017 Last revised: 2 Dec 2023
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Rating on a Behavioral Curve
Rating on a Behavioral Curve
Date Written: 2023
Abstract
Sell-side analysts rate on a behavioral curve. Although they claim to use objective criteria (like expected raw, market-adjusted, or industry-adjusted returns), we find that, even after controlling for these claims, their recommendations on a particular stock are negatively influenced by their assessment of quality of the few other stocks they have rated recently. Even non-industry peers affect the ratings. We also find that this bias has price implications. The next day's alpha of a sophisticated trading strategy that incorporates this bias is about 43% higher compared to the alpha of an unsophisticated strategy that uses rating information only.
Keywords: reference dependence, relative rating, analyst recommendations, target price
JEL Classification: D91, G11, G14, G24, G40
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