Stock Price Reactions to the Information and Bias in Analyst-Expected Returns

Abstract

I use a novel decomposition to estimate information and bias components from the returns implied by analyst price targets and provide evidence that prices simultaneously underreact to information and overreact to bias. Price reactions to information are permanent and prices drift in the direction of their initial reaction for up to 12 months. Price reactions to bias are transitory and prices reverse their initial reaction after about 3 months. Price reactions are relatively efficient. Approximately 85% of the total price reaction to information occurs during price target announcement months. Market participants are able to mostly (but not fully) debias analyst-expected returns before incorporating them into prices, with the announcement-month reaction to bias being relatively weak at about 15% of its reaction to information. A trading strategy analysis implies that mispricing induced by bias is only about 1/3 of that implied by prior research.

Keywords: Expected returns, Cross section, Analysts, Price targets, Market efficiency, Price drift, Return reversal

JEL Classification: G12, G14, G40