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Rationality and Analysts' Forecast Bias

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  • Terence Lim

Abstract

This paper proposes and tests a quadratic‐loos utility function for modeling corporate earnings forecasting, where financial analysts trade off bias to improve management access and forecast accuracy. Optimal forecasts with minimum expected error are optimistically biased and exhibit predictable cross‐sectional variation related to analyst and company characteristics. Empirical evidence from individual analyst forecasts is consistent with the model's predictions. These results suggest that positive and predictable bias may be a rational property of optimal earnings forecasts. Prior studies using classical notions of unbiasedness may have prematurely dismissed analysts' forecasts as being irrational or inaccurate.

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  • Terence Lim, 2001. "Rationality and Analysts' Forecast Bias," Journal of Finance, American Finance Association, vol. 56(1), pages 369-385, February.
    • Handle: RePEc:bla:jfinan:v:56:y:2001:i:1:p:369-385
    DOI: 10.1111/0022-1082.00329
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