Investor (Mis)Reaction, Biased Beliefs, and the Mispricing Cycle
67 Pages Posted: 28 Nov 2021
Date Written: November 19, 2021
We construct a new measure that captures the disparity between the market reaction to earnings information and the earnings surprise ("Return-Earnings Gap", "REG"). High REG scores positively predict analyst forecast errors and firm mispricing (overvaluation) scores, especially for build-up anomalies. Analyst forecast errors are slower to converge when REG provides confirming information. In turn, REG is positively predicted by analyst forecasts errors and higher mispricing, leading to a continuation of firm overvaluation over a few quarters. Overall, our results reveal how the market's (mis)reaction feeds back into the belief formation of analysts, which partially explains the slow correction of firm mispricing.
Keywords: Investor beliefs, analysts, mispricing, misreaction
JEL Classification: G00, G12, G14, G40, G41
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