Financial Analysts Impact on Stock Volatility: A Study on the Pharmaceutical Sector
FEDEA Working Paper No. 2008-19
30 Pages Posted: 14 May 2008
Date Written: May 1, 2008
The arrival of new information helps financial markets to value assets, but it may has the side-effect of increasing their volatilities. A better knowledge of the mechanism that links relevant news and stock prices would help both private and institutional agents to improve the calibration of the risks implies in a given asset.
Financial analysts play a key role in distinguishing which news are relevant for the valuation of a particular asset, and the changes in their recommendations are signals of new information in the market.
This paper studies the impact those buy or sell recommendations have on returns and also on volatility instead of the traditional literature that focuses only on prices. The pharmaceutical companies in the New York Stock Exchange are especially suited for this type of analysis given the frequent discontinuities in their expected profits derived from the success or failure in the development of new drugs.
Twenty stocks are daily tracked for five years along with the recommendations given by financial analysts. We have modeled stock returns by a Markov Regime Switching model as in Schaller and van Norden (1997) and found two states of low and high volatilities. We have also found strong evidence that the probability of being in the estate of high volatility increases when a Financial Analyst changes his recommendation.
Keywords: Financial analysts, news arrival, pharmaceutical companies, Markov Regime Switching model
JEL Classification: G14, C22, L65
Suggested Citation: Suggested Citation