Surprising Absence of Scale for Forecast Error Magnitudes and Forecast Dispersion
37 Pages Posted: 24 Oct 2009
Date Written: October 20, 2009
While levels of actual and consensus forecast earnings per share (EPS) vary with scale (measured typically by share price), magnitudes of the difference do not vary with scale. That is, forecast errors within a certain range (e.g., plus/minus 5 cents per share) are equally likely for both high-price and low-price shares. We also find a similar lack of variation with scale for forecast dispersion, representing magnitudes of the difference between individual forecasts and the consensus (mean) for that firm-quarter. The prior literature has assumed that magnitudes of forecast errors (representing predictability) and forecast dispersion (representing disagreement across analysts) vary naturally with scale and has deflated both variables accordingly. We show that such scaling is likely to cause biased estimates, and recommend that scaling not be used, unless called for by theory. Regardless, a scale variable should be included as an additional regressor.
Keywords: Analyst Forecast, Predictability, Disagreement, Deflator
JEL Classification: G12, G14, G34, M41
Suggested Citation: Suggested Citation