Investors’ Misweighting of Firm-level Information and the Market’s Expectations of Earnings

Posted: 5 Dec 2019

See all articles by Sami Keskek

Sami Keskek

Florida State University

James N. Myers

University of Tennessee, Knoxville - College of Business Administration

Linda A. Myers

University of Tennessee, Haslam College of Business, Accounting and Information Management

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Date Written: November 20, 2019

Abstract

Prior studies use fundamental earnings forecasts to proxy for the market’s expectations of earnings because analyst forecasts are biased and are available for only a subset of firms.  We find that as a proxy for market expectations, fundamental forecasts contain systematic measurement errors analogous to those in analysts’ biased forecasts.  Therefore, these forecasts are not representative of investors’ beliefs. The systematic measurement errors from using fundamental forecasts to proxy for market expectations occur because investors misweight the information in many firm-level variables when estimating future earnings, but fundamental forecasts are formed using the historically efficient weights on firm-level variables.  Thus, we develop an alternative ex ante proxy for the market’s expectations of future earnings (‘the implied market forecast’) using the historical (and inefficient) weights, as reflected in stock returns, that the market places on firm-level variables.  A trading strategy based on the implied market forecast error, which is measured as the difference between the implied market forecast and the fundamental forecast, generates excess returns of approximately nine percent per year. These returns cannot be explained by investors’ reliance on analysts’ biased forecasts.  Overall, our results reveal that market expectations differ from both fundamental forecasts and analysts’ forecasts.

Keywords: Market expectations, Mispricing, Fundamental earnings forecasts, Analyst Forecasts, Measurement errors, Investor beliefs

JEL Classification: M4, M40, M41

Suggested Citation

Keskek, Sami and Myers, James N. and Myers, Linda A., Investors’ Misweighting of Firm-level Information and the Market’s Expectations of Earnings (November 20, 2019). Contemporary Accounting Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3493296

Sami Keskek

Florida State University ( email )

Department of Accounting
College of Business
Tallahassee, FL 32306
United States

James N. Myers

University of Tennessee, Knoxville - College of Business Administration ( email )

Haslam Business Building
Knoxville, TN
United States

Linda A. Myers (Contact Author)

University of Tennessee, Haslam College of Business, Accounting and Information Management ( email )

Knoxville, TN
United States

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