Dispersion of Forecasts and Stock Returns

Abstract

Prior research has established that stocks with high dispersion of earnings forecasts yield lower subsequent returns. I offer a new explanation based on some analysts' reluctance to revise their forecasts downward. I show that analysts' sluggish and non-synchronous response to negative information results in dispersion of forecasts. The inertia in downward forecast revisions also leads to market underreaction to bad news. Therefore, the negative relationship between dispersion and subsequent returns may be partially attributable to some analysts' sluggish response to negative information. I also test whether dispersion of forecasts exacerbates overpricing (Miller (1977)), but find that when dispersion of forecasts increases, prices decrease.

Keywords: dispersion of forecasts, short sale constraints, stock returns