A Catering Theory of Analyst Bias

25 Pages Posted: 21 May 2004

See all articles by Richard K. Lai

Richard K. Lai

The Wharton School, Univ. of Pennsylvania

Date Written: May 20, 2004


We posit a theory that runs counter to how conventional wisdom thinks about analyst bias, that it is the result of distorted incentives by "the system" - especially upstream factors like the analysts' employers. We suggest that analysts are also heavily influenced by what investors believe, the purported victims of analyst bias. We adapt Mullainathan-Shleifer's theory of media bias to build a theory of how analysts cater to what investors believe. The theory also predicts that competition among analysts does not reduce their bias. We provide empirical support for this theory, using an enormous dataset built from over 6.5 million analyst estimates and 42.8 million observations on investor holdings, which we argue is a proxy for what they believe. We use a simultaneous-equations model for estimation, with instruments to rule out alternative interpretations of the direction of causality. For additional robustness, we investigate the time series of analyst bias and heterogeneity in investor beliefs from 1987 through 2003. Dickey-Fuller tests show that both have unit roots, but we establish that cointegration hold. Further, we employ a vector-autoregressive model to show Granger - causality between the two.

Keywords: Analyst bias, behavioral finance, media bias

JEL Classification: G10, G20, G39

Suggested Citation

Lai, Richard K., A Catering Theory of Analyst Bias (May 20, 2004). Available at SSRN: https://ssrn.com/abstract=548582 or http://dx.doi.org/10.2139/ssrn.548582

Richard K. Lai (Contact Author)

The Wharton School, Univ. of Pennsylvania ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States
215 898 1630 (Phone)

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