Does Analyst Optimism Fuel Stock Price Momentum?

Abstract

Researchers have struggled to find rational risk factors that explain momentum profits derived from buying prior winners and shorting prior losers. Behavioral explanations have been offered that focus on tendencies of investors to underreact to news and recommendations. Our study provides an alternative explanation centered on the behavior of sell-side analysts. We find a change in consensus recommendation from a hold to a buy is accompanied by an increase in momentum profits of 3.33 percent annually. Momentum profits fall, yet remain material, after the passage of Reg FD. Our results support a behavioral explanation in which investor cognitive biases are fueled by analyst recency and optimism biases. Contrary to prior studies, we find company fundamentals and information uncertainty alone do not explain momentum profits. Instead, analyst affirmation is a key catalyst.

* Preliminary Draft: Not for quotation

Note: Preliminary Draft: Not for quotation.

Keywords: sell-side analysts; cognitive biases; recommendation optimism; stock price momentum

JEL Classification: G1, G14, G24