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Correlated Errors - Why a Monotone Relationship between Forecast Precision
and Trading Profitability May Not Hold

40 Pages Posted: 14 Feb 2009 Last revised: 1 Mar 2012

Jochen Lawrenz

University of Innsbruck

Alex Weissensteiner

Free University of Bolzano/Bozen

Date Written: February 27, 2012

Abstract

This paper argues that the relation between financial analysts' earnings forecast accuracy and their recommendation profitability has to be augmented by the extent of commonality in their forecast errors. We show that while accuracy is positively related to expected performance, the correlation in forecasting errors has a negative impact. This implies that a monotonic relationship between ex ante identifiable forecast accuracy and ex post recommendation profitability does not need to hold. Thus, agents may be better off by making comparatively large but less correlated errors, than making precise but highly correlated forecasts.

Keywords: Forecast accuracy, analysts recommendation profitability, learning, Kalman filter

JEL Classification: M4, G14

Suggested Citation

Lawrenz, Jochen and Weissensteiner, Alex, Correlated Errors - Why a Monotone Relationship between Forecast Precision and Trading Profitability May Not Hold (February 27, 2012). Available at SSRN: https://ssrn.com/abstract=1342916 or http://dx.doi.org/10.2139/ssrn.1342916

Jochen Lawrenz

University of Innsbruck ( email )

Universitätsstraße 15
Innsbruck, Innsbruck 6020
Austria
++43-512-507-7582 (Phone)

Alex Weissensteiner (Contact Author)

Free University of Bolzano/Bozen ( email )

Universitätsplatz 1
Bolzano/Bozen, 39100
Italy
+39 0471 013496 (Phone)

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