Excessive Optimism and Analyst Recommendations
This blog post taps into some of the theories outlined by behavioral finance. Specifically I’m going to look at research done on what is called overconfidence. Overconfidence among investors can manifest itself in many ways. One of these forms is excessive optimism (or pessimism) with regards to beliefs in future outcome. Carleton, Chen, and Steiner (1998) and Jegadeesh, and Kim (2003) study the value of analyst recommendations. There are two aspects worth considering specifically in this context. The first is the quality of the recommendations and the second is the market reaction to them. The value of an analyst report can be defined as its impact on the market, thus the quality of the report and market reaction is not mutually exclusive but rather tightly linked. This poses some potential issues as there might be a feedback loop at work here, where analysts with a broader audience could potentially have a bigger impact than more unknown analysts with less exposure. However, given that the topic in question is an anomaly of the efficient market hypothesis, this potential feedback loop is of interest. In an efficient market, any new information in the form of a buy/sell recommendation must only have an immediate impact without any positive serial correlation in future abnormal returns if it represents new information. I will begin by analyzing a number of aspects related to analyst recommendations and proceed to cover market impact. ...