Rational Inattention and Analyst Forecast Accuracy

52 Pages Posted: 19 Oct 2018

See all articles by Phong Truong

Phong Truong

Pennsylvania State University

Date Written: September 21, 2018

Abstract

Facing limited attention constraints, financial analysts must strategically choose which information to pay attention to and which information to ignore when making earnings forecasts. I rely on rational inattention theory to develop and test hypotheses on factors that determine analyst attention and how analyst attention affects forecast accuracy. I construct a novel measure of attention that varies across stocks followed by the same analyst during the same fiscal period. I find that analyst attention is decreasing in the marginal cost of paying attention and that analysts allocate attention to firms with earnings that are difficult to forecast, suggesting that analysts suffer from a limited attention constraint. Importantly, I find that attentive analysts are more accurate, and the effect of attention is larger for inexperienced analysts and stocks with highly volatile earnings. Finally, I find that attentive analysts are less likely to revise forecasts upwards and are less optimistic even after controlling for firm information environment and analyst ability.

Keywords: Inattention, Analysts, Earnings Forecasts, Forecast Accuracy, Behavioral Finance

JEL Classification: D80, G24, G4, M41

Suggested Citation

Truong, Phong, Rational Inattention and Analyst Forecast Accuracy (September 21, 2018). Available at SSRN: https://ssrn.com/abstract=3257433 or http://dx.doi.org/10.2139/ssrn.3257433

Phong Truong (Contact Author)

Pennsylvania State University ( email )

University Park
State College, PA 16802
United States
16802 (Fax)

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