Noise from Other Industries: Overgeneralization and Analyst Beliefs

71 Pages Posted: 4 Jun 2018 Last revised: 28 Mar 2019

See all articles by Renjie Wang

Renjie Wang

Erasmus University Rotterdam (EUR), Erasmus School of Economics (ESE), Students

Date Written: March 15, 2019

Abstract

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

Wang, Renjie, Noise from Other Industries: Overgeneralization and Analyst Beliefs (March 15, 2019). Paris December 2018 Finance Meeting EUROFIDAI - AFFI. Available at SSRN: https://ssrn.com/abstract=3190088 or http://dx.doi.org/10.2139/ssrn.3190088

Renjie Wang (Contact Author)

Erasmus University Rotterdam (EUR), Erasmus School of Economics (ESE), Students ( email )

P.O. Box 1738
Rotterdam, NL 3062 PA
Netherlands

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