Do security analysts speak in two tongues?
By: Ulrike Malmendier, Devin Shanthikumar.
Contributors: Shanthikumar, Devin.; National Bureau of Economic Research.
Series: NBER working paper series -- no. 13124.; Working paper series (National Bureau of Economic Research) -- working paper no. 13124.
Publisher: National Bureau of Economic Research
Published: 2007
Place of publication: Cambridge, Mass
Language: eng
Number of pages: 30
Subjects: Investment analysis -- Mathematical models; Investment advisors -- Mathematical models; Stocks -- Forecasting -- Mathematical models
Description: "Why do analysts display overoptimism about the stocks they cover? According to the selection hypothesis, analysts pick their favorite stocks and are truly too optimistic. According to the conflict-of-interest hypothesis, analysts distort their view to maximize profits via commissions and underwriting business, in particular if affiliated with an underwriting bank. We analyze the concurrent issuance of recommendations and earnings forecasts to assess the relative importance of both explanations for affiliated and for unaffiliated analysts. First, we show that recommendations and forecasts reach different audiences. Small traders follow recommendations but not forecast updates; large traders discount recommendations and follow earnings forecasts. As a result, analysts may choose to distort recommendations but prove their analyst quality in their forecasts. The selection hypothesis implies, instead, a positive correlation between recommendation and forecast overoptimism. We find that, while affiliated analysts issue more optimistic recommendations than unaffiliated analysts, their earnings forecasts are more pessimistic. Moreover, forecast optimism is negatively correlated with recommendation optimism for affiliated analysts but positively for unaffiliated analysts. Similar discrepancies between the timing of recommendations and forecasts confirm that active distortion is a major explanation for the recommendation optimism of affiliated analysts."--abstract.
Notes: "May 2007"

Includes bibliographical references (p. 29-30).

Also available in PDF from the NBER world wide web site (www.nber.org).