Do Excessively Volatile Forecasts Impact Investors?
Lundholm, Russell, and Rafael Rogo. "Do excessively volatile forecasts impact investors?." Review of Accounting Studies (2020): 1-36.
62 Pages Posted: 22 Oct 2019 Last revised: 13 Aug 2020
Date Written: March 1, 2019
There is a logical bound on the time-series variability of analyst forecasts; when variability exceeds this bound it must be caused by something besides statistically rational forecasting. We document occurrences of excessively volatile analyst forecasts and show that they influence investment performance. Comparing trading rules based on forecasts that are excessively volatile and those that are not, we find the returns to investing based on the former are significantly lower, with higher daily volatility, and a lower Sharpe ratio. We also show that returns to trading based on excessively volatile forecasts underperform the most when there is little news arriving and when the news that does arrive is relatively neutral. In this region, it is hardest to argue that analysts are unwittingly overreacting to news; instead, they appear to be intentionally making extreme forecasts to curry favor with management or to differentiate themselves from other analysts.
Keywords: analyst forecasts, excess volatility
JEL Classification: G14, M41
Suggested Citation: Suggested Citation