Rationalizing Forecast Inefficiency

Review of Accounting Studies, Forthcoming

Posted: 8 Jul 2021

See all articles by Charles (Chad) Ham

Charles (Chad) Ham

Washington University in St. Louis - John M. Olin Business School

Zachary Kaplan

Washington University in St. Louis - John M. Olin Business School

Zawadi Lemayian

Washington University in St. Louis

Multiple version iconThere are 2 versions of this paper

Date Written: June 23, 2021

Abstract

We show analysts’ own earnings forecasts predict error in their own forecasts of earnings at other horizons, which we argue provides a measure of the extent to which analysts inefficiently use information. We construct our measure by exploiting two sources of variation in analysts’ incentives: (i) more recent forecasts have greater salience at the time of the earnings release so accuracy incentives are higher (lower) at shorter (longer) forecast horizons and (ii) analysts have greater incentives for optimism (pessimism) at longer (shorter) horizons. Consistent with these incentives affecting the incorporation of information into forecasts, we document (i) current year forecasts underweight (overweight) information in shorter (longer) horizon forecasts and (ii) the mis-weighting is more pronounced when recent news is negative—when analysts have greater (weaker) incentives to incorporate the news into shorter (longer) horizon forecasts. Finally, returns tests suggest that forecasts adjusted for the inefficiency we document better represent market expectations of earnings.

Keywords: sell-side analysts, forecast bias, forecast horizon, analyst forecasts

Suggested Citation

Ham, Charles and Kaplan, Zachary and Lemayian, Zawadi, Rationalizing Forecast Inefficiency (June 23, 2021). Review of Accounting Studies, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3872936

Charles Ham (Contact Author)

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Zachary Kaplan

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Zawadi Lemayian

Washington University in St. Louis ( email )

One Brookings Drive
Campus Box 1208
Saint Louis, MO MO 63130-4899
United States

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