Bias in Analysts' Earnings Forecasts
University of Tennessee, Finance Working Paper
39 Pages Posted: 28 Apr 2003
Date Written: January 2003
If either economic incentives or psychological phenomena cause the bias in analysts' forecasts to persist long enough, it would be potentially discoverable and exploitable by investors. "Exploitation" in this context implies that investors, through examination of historical forecasting performance, can more or less reliably estimate the direction and extent of bias, and impute unbiased estimates for themselves, given analysts' forecasts. The absence of persistence in forecast errors would suggest that analysts' own behavior ultimately "self-corrects" within a time frame that eliminates the possibility that the patterns could be exploited by investors. We use two look-back methods that capture salient features of analysts' past forecasting behavior to form quintile portfolios that describe the range of analysts' forecasting behavior. Parametric and nonparametric tests are performed to determine whether the two portfolio formation methods provide predictive power with respect to subsequent forecast errors. The findings support a conclusion that analysts' behaviors in both optimistic and pessimistic extremes do not entirely self-correct, leaving open the possibility that investors may find historical forecast errors useful in making inferences about current forecasts.
Keywords: earnings forecasts, analysts' optimism, earnings forecast errors, investor rationality
JEL Classification: G14, G24
Suggested Citation: Suggested Citation
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