Signal Strength, Conflicting Signals and Beliefs Updating: Evidence From Sell-Side Analysts' Forecasts
48 Pages Posted: 30 Jun 2021 Last revised: 9 Jul 2021
Date Written: June 19, 2021
I empirically study how confirmatory bias works for strong and contradictory signals using data on sell-side analysts. I first model an agent who is prone to confirmatory bias and whose task is to value a stock based on a signal, and introduce the effects of the signal strength by relaxing Rabin and Schrag's (1999) assumption of a constant bias severity. Afterwards I use target prices to measure forecast bias and the growth in Earnings Per Share as signals, and regress analysts' forecast bias over different deciles of favorable signals interacted with prior negative forecast bias in a dynamic panel data model. I find that analysts do not react positively to favorable signals when the prior is pessimistic, except for sufficiently strong signals which cause analysts to issue more optimistic target prices.
Keywords: Bayesian updating, misinterpretation, pessimistic prior, optimistic forecast
JEL Classification: G17, G11, G41
Suggested Citation: Suggested Citation