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Do excessively volatile forecasts impact investors?

Author

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  • Russell Lundholm

    (University of British Columbia)

  • Rafael Rogo

    (Indiana University)

Abstract

There is a logical bound on the time-series variability of analyst forecasts; when variability exceeds this bound it must be caused by something besides statistically rational forecasting. We document occurrences of excessively volatile analyst forecasts and show that they influence investment performance. Comparing trading rules based on forecasts that are excessively volatile and those that are not, we find the returns to investing based on the former are significantly lower, with higher daily volatility, and a lower Sharpe ratio. We also show that returns to trading based on excessively volatile forecasts underperform the most when there is little news arriving and when the news that does arrive is relatively neutral. In this region, it is hardest to argue that analysts are unwittingly overreacting to news; instead, they appear to be intentionally making extreme forecasts to curry favor with management or to differentiate themselves from other analysts.

Suggested Citation

  • Russell Lundholm & Rafael Rogo, 2020. "Do excessively volatile forecasts impact investors?," Review of Accounting Studies, Springer, vol. 25(2), pages 636-671, June.
    • Handle: RePEc:spr:reaccs:v:25:y:2020:i:2:d:10.1007_s11142-019-09522-y
    DOI: 10.1007/s11142-019-09522-y
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    References listed on IDEAS

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    Cited by:

    1. Paul Fischer & Chongho Kim & Frank Zhou, 2022. "Disagreement about fundamentals: measurement and consequences," Review of Accounting Studies, Springer, vol. 27(4), pages 1423-1456, December.

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    More about this item

    Keywords

    excess volatility; analyst forecasts;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • M49 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Other

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