When Sell-Side Analysts Meet High-Volatility Stocks: An Alternative Explanation for the Low-Volatility Puzzle

Journal Of Investment Management (JOIM), Second Quarter 2013

Posted: 15 Jun 2013

See all articles by Jason C. Hsu

Jason C. Hsu

Rayliant Global Advisors; Research Affiliates, LLC; University of California, Los Angeles - Anderson School of Business

Hideaki Kudoh

Nomura Asset Management Co., Ltd. (NAM)

Toru Yamada

Nomura Holdings, Inc. (NHI) - Nomura Asset Management Co., Ltd. (NAM)

Multiple version iconThere are 2 versions of this paper

Date Written: June 14, 2013

Abstract

Using a global equity dataset that includes emerging markets, we confirm that high-volatility stocks tend to deliver low average returns; this effect is robust to adjustments for for country and style factors. We also show that sell-side analysts earnings growth forecasts for high-volatility stocks are more biased. It is well-known that sell-side analysts are predictably optimistic; however, the relationship between the degree of optimism and a stocks volatility has not been documented before. We hypothesize that analysts inflate earnings forecasts more aggressively for volatile stocks, in part because the inflation would be more difficult for investors to detect. Because investors are known to overreact to analyst forecasts (under-adjust to analyst bias), this contributes to systematic overvaluation and low returns for high-volatility stocks. Additionally, we find sell-side analysts research informative despite the biases; stocks that have high forward E/P ratios based on analyst earnings forecasts tend to outperform and produce significantly positive FamaFrench alphas. This evidence rejects the cynical view of some in our industry that sell-side analysts are unskilled. More interestingly, we find high forward E/P stocks also exhibit high analyst bias, which supports an interpretation that analysts are more willing to inflate earnings forecasts for stocks that they believe are likely to deliver high returns or for which their inflated forecasts are likely to do no harm.

Keywords: Analyst forecast bias, low volatility puzzle

JEL Classification: G00

Suggested Citation

Hsu, Jason C. and Kudoh, Hideaki and Yamada, Toru, When Sell-Side Analysts Meet High-Volatility Stocks: An Alternative Explanation for the Low-Volatility Puzzle (June 14, 2013). Journal Of Investment Management (JOIM), Second Quarter 2013. Available at SSRN: https://ssrn.com/abstract=2279594

Jason C. Hsu (Contact Author)

Rayliant Global Advisors ( email )

Hong Kong

Research Affiliates, LLC ( email )

620 Newport Center Dr
Suite 900
Newport Beach, CA 92660
United States

HOME PAGE: http://www.jasonhsu.org

University of California, Los Angeles - Anderson School of Business

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Hideaki Kudoh

Nomura Asset Management Co., Ltd. (NAM) ( email )

Dai-ichi Edobashi Building
1-11-1, Nihonbashi, Chuo-ku
Tokyo, 103-8260
Japan

HOME PAGE: http://www.nomura-am.co.jp/

Toru Yamada

Nomura Holdings, Inc. (NHI) - Nomura Asset Management Co., Ltd. (NAM) ( email )

Japan

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