Do Analysts’ Target Prices Stabilize the Stock Market?

62 Pages Posted: 25 Mar 2021

See all articles by Markus Buxbaum

Markus Buxbaum

University of Augsburg

Wolfgang Schultze

University of Augsburg

Samuel L. Tiras

Indiana University - Kelley School of Business

Date Written: January 21, 2021

Abstract

If target prices are reflective of the true value of a stock, they should correctly reflect the market’s over- and underpricing, that is, be negatively associated with investor sentiment. However, empirical evidence of Clarkson et al. (2020) finds the opposite. Prior research offers two competing explanations for why target prices may not be informative: (1) analysts’ optimism, and (2) analysts’ use of less sophisticated valuation methods. We examine the effect of the interrelation between investor sentiment, target price optimism, and the analyst’s inferred use of sophisticated valuation methods on the informativeness of target prices. Contrary to conventional wisdom that believes target price optimism would always weaken the informativeness of target prices, we find that when investor sentiment is low, target price optimism has a positive effect on the informativeness of target prices. Analysts’ continuous target price optimism drives target prices away from fundamentals in high sentiment, while optimistic target prices are closer to intrinsic values in low sentiment. Target price informativeness is highest for target prices that are inferred to be based on more sophisticated valuation methods during periods of low sentiment. In high sentiment, however, the informativeness of target prices is close to zero, irrespective of the valuation methods used. This suggests that analysts’ optimism works in favor of the informativeness in low sentiment but is distortive in high sentiment. Further, market reactions to target price revisions do not reflect the higher informativeness in low sentiment. Rather, investors overreact to target price revisions in high sentiment, potentially fueling bubbles.

Keywords: investor sentiment, target price optimism

JEL Classification: M31

Suggested Citation

Buxbaum, Markus and Schultze, Wolfgang and Tiras, Samuel L., Do Analysts’ Target Prices Stabilize the Stock Market? (January 21, 2021). Available at SSRN: https://ssrn.com/abstract=3772279 or http://dx.doi.org/10.2139/ssrn.3772279

Markus Buxbaum

University of Augsburg ( email )

Universitätsstr. 2
Augsburg, 86159
Germany

Wolfgang Schultze (Contact Author)

University of Augsburg ( email )

Augsburg, 86135
Germany

Samuel L. Tiras

Indiana University - Kelley School of Business ( email )

801 W. Michigan Street
Indianapolis, IN 46202
United States
(317) 274-3420 (Phone)

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