Noise from Other Industries: Overgeneralization and Analyst Beliefs
71 Pages Posted: 4 Jun 2018 Last revised: 28 Mar 2019
Date Written: March 15, 2019
How do analysts form earnings expectations? This paper documents that analysts’ beliefs are influenced by the performance of other industries that they cover. I find that negative shocks to one coverage industry lead analysts to make more pessimistic earnings forecasts for firms in another industry. Those pessimistic forecasts are less accurate and lower than the actual earnings. Analysts are affected even if the focal firms have no relationship with the shocked industry. These findings are not in line with information spillovers, but rather consistent with the notion that analysts heuristically overgeneralize bad news from other coverage industries and incorrectly lower their expectations about the focal firms. Moreover, I show that analyst overgeneralization has significant effects on the financial market: the resulting increase in analyst disagreement induces higher trading volumes and larger return volatilities, and the resulting analysts’ pessimism leads to temporary underpricing.
Keywords: Behavioral Finance, Financial Analyst, Product Market Relationships
JEL Classification: D84, G2, G41
Suggested Citation: Suggested Citation