Broker Recommendations and Australian Small-Cap Equity Fund Management
29 Pages Posted: 23 Jan 2010 Last revised: 23 Apr 2010
Date Written: January 20, 2010
This study examines the extent to which the abnormal performance of active Australian small-cap equity fund managers, previously documented by Chen et al. (2010), is associated with broker recommendations. Our empirical evidence supports the investment value of broker recommendations, showing statistically significant cumulative abnormal returns both pre and post broker recommendation dates. We find that a factor-mimicking portfolio based on broker recommendations results in a 48 basis point reduction in annual alphas estimated from a Carhart (1997) four-factor model (from 58 to 54 basis points a month). Using transaction-level data, buy trades following recommendations earn statistically significant cumulative abnormal returns of 1.56 percent after 60 days. Overall, we find evidence suggesting that broker recommendations play an important role in the investment decisions of small-cap fund managers, and these account for an economically significant component of the monthly alphas.
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