Identifying the News in Analysts’ Earnings Forecasts Revisions: An Alternative to the Random Walk Expectation

Previous research indicates that analysts’ forecasts are superior to time series models as measures of investors’ earnings expectations. Nevertheless, research also documents predictable patterns in analysts’ forecasts and forecast errors. If investors are aware of these patterns, analysts’ forecast revisions measured using the random walk expectation are an incomplete representation of changes in investors’ earnings expectations. Investors can use knowledge of errors and biases in forecasts to improve upon the simple random walk expectation by incorporating conditioning information. Using data from 2005 to 2015, we compare associations between market-adjusted stock returns and alternative specifications of forecast revisions to determine which best represents changes in investors’ earnings expectations. We find forecast revisions measured using a ‘bandwagon expectations’ specification, which includes two prior analysts’ forecast signals and provides the most improvement over random-walk-based revision measures. Our findings demonstrate benefits to considering information beyond the previously issued analyst forecast when representing investors’ expectations of analysts’ forecasts.

How Completely Do Analysts Incorporate Firm-Specific and Industry Information in Their Forecasts? Evidence and Implications for Post-Forecast Revision Drift

Prior studies find a positive relation between analyst forecast revisions and upcoming news, suggesting that analysts’ forecast revisions are incomplete with respect to available information. In this study, we use the association between forecast revisions and upcoming news to measure forecast completeness and show that post-forecast-revision drift is higher when forecasts are incomplete. We follow Hui and Yeung’s (2013) approach to separate forecast revision news into industry-wide and firm-specific components because they find that drift is primarily associated with the industry component. We find that forecast revisions are less complete for industry-wide news than for firm-specific news. Furthermore, analysts’ industry-wide revisions are less complete early in the year and when the underlying news is bad, and we find stronger post-forecast-revision drift in those cases. We also show that analysts who were optimistic in prior periods tend to issue forecasts that are less complete and that generate stronger drift than forecasts by other analysts. Our findings provide an explanation for the drift that contrasts with prior studies that attribute the drift to investors’ slow assimilation of the news in forecast revisions. Thus, our study sheds light on analysts’ role in conveying firm-specific and industry-wide news to investors and on the implications for post-forecast-revision drift.

Market Participants Neither Commit Predictable Errors nor Conform to REH: Evidence from Survey Data of Inflation Forecasts

We develop a novel characterization of participants’ forecasts with a mixture of normal variables arising from a Markov component. Using this characterization, we formulate five behavioral specifications, including four implied by the diagnostic expectations approach, as well as three implied by REH, and derive several new predictions for Coibion and Gorodnichenko.s regression of forecast errors on forecast revisions. Predictions of all eight specifications are inconsistent with the observed instability of individual CG regressions’ coefficients, based on inflation forecasts from 24 professionals. Our findings suggest how to build on key insights of the REH and behavioral approaches in specifying individuals’ forecasts.

Individual investors' responses to mutual fund fire sales and sell-side analysts' price-correcting revisions

PurposeThis paper investigates individual investors' responses to stock underpricing and how their trading decisions are affected by analysts' forecasts and recommendations.Design/methodology/approachThis empirical study uses mutual fund fire sales as an exogenous source that causes stock underpricing and analysts' forecasts and recommendations as price-correcting information. The study further uses regression analysis to examine individual investors' responses to fire sales and how their responses vary with price-correcting information.FindingsThe authors first show that individual investors respond to mutual fund fire sales by significantly decreasing net buys, and this effect appears to be prolonged. Next, the authors find that the decrease of net buys diminishes following analysts' price-correcting earnings forecast revisions and stock recommendation changes. Hence, the authors suggest that individual investors are not “wise” enough to recognize flow-driven underpricing; however, this response is weakened by analysts' price-correcting information.Originality/valueThere is an ongoing debate in the literature about whether individual investors should be portrayed as unsophisticated traders or informed traders who can predict future returns. The authors study a unique information event and provide new evidence related to both perspectives. Overall, our evidence suggests that the “unsophisticated traders” perspective is predominant, whereas a better information environment significantly reduces individual investors' information disadvantage. This finding could be of interest to both academic researchers and regulators.