Valuation Bias and Limits to Nudges

Posted: 16 Aug 2018 Last revised: 27 Aug 2018

See all articles by Hersh Shefrin

Hersh Shefrin

Santa Clara University - Leavey School of Business

Date Written: August 2, 2018

Abstract

Because of limits to arbitrage, it is reasonable for sell-side analysts’ target prices to deviate from their corresponding estimates of future fundamental value. Although this inequality does not imply that sell-side analysts should provide biased estimates of fundamental value, many do. A key contributor to this bias is the unwarranted assumption that in the long run, firms can be expected to earn more than their cost of capital. Biased estimates of fundamental value can harm long-term investors. At the same time, there are simple nudges that can help avoid the bias. Nevertheless, limits to nudges associated with buy-side catering prevent their application. The magnitude of the associated bias can be substantial for the stocks of large firms that dominate the market. Notably, sell-side analysts’ upwardly biased estimated fundamental values for these stocks lie in the vicinity of consensus target prices and market prices. This suggests that valuation bias associated with stocks of large firms that dominate the market is consistent with intermittent overvaluation of these stocks and the overall market.

Keywords: sell-side analysts, growth opportunities bias, nudge, buy-side catering

JEL Classification: G02, G12

Suggested Citation

Shefrin, Hersh, Valuation Bias and Limits to Nudges (August 2, 2018). Journalof Portfolio Management, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3225439 or http://dx.doi.org/10.2139/ssrn.3225439

Hersh Shefrin (Contact Author)

Santa Clara University - Leavey School of Business ( email )

Dept. of Finance
Santa Clara, CA 95053
United States
408-554-6893 (Phone)
408-554-4029 (Fax)

Register to save articles to
your library

Register

Paper statistics

Abstract Views
220
PlumX Metrics