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Shrunken earnings predictions are better predictions

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  • Manfred Keil
  • Gary Smith
  • Margaret Smith
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    Abstract

    Analysts' earnings forecasts are not perfectly correlated with actual earnings. One statistical consequence is that the most optimistic and most pessimistic forecasts are usually too optimistic and too pessimistic. The forecasts' accuracy can be improved by shrinking them towards the mean. Insufficient appreciation of this statistical principle may partly explain the success of contrarian investment strategies, in particular why stocks with the most optimistic earnings forecasts underperform those with the most pessimistic forecasts.

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    File URL: http://www.tandfonline.com/doi/abs/10.1080/0960310042000284678
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    Bibliographic Info

    Article provided by Taylor & Francis Journals in its journal Applied Financial Economics.

    Volume (Year): 14 (2004)
    Issue (Month): 13 ()
    Pages: 937-943

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    Handle: RePEc:taf:apfiec:v:14:y:2004:i:13:p:937-943

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    1. Fama, Eugene F & French, Kenneth R, 1992. " The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-65, June.
    2. De Bondt, Werner F M & Thaler, Richard, 1985. " Does the Stock Market Overreact?," Journal of Finance, American Finance Association, vol. 40(3), pages 793-805, July.
    3. Eugene F. Fama & Kenneth R. French, . "Forecasting Profitability and Earnings," CRSP working papers 358, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
    4. Fama, Eugene F & French, Kenneth R, 1988. "Permanent and Temporary Components of Stock Prices," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 246-73, April.
    5. Poterba, James M. & Summers, Lawrence H., 1988. "Mean reversion in stock prices : Evidence and Implications," Journal of Financial Economics, Elsevier, vol. 22(1), pages 27-59, October.
    6. De Bondt, Werner F M & Thaler, Richard H, 1987. " Further Evidence on Investor Overreaction and Stock Market Seasonalit y," Journal of Finance, American Finance Association, vol. 42(3), pages 557-81, July.
    7. Chan, Louis K C & Hamao, Yasushi & Lakonishok, Josef, 1991. " Fundamentals and Stock Returns in Japan," Journal of Finance, American Finance Association, vol. 46(5), pages 1739-64, December.
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    Cited by:
    1. H. E. Roman & R. A. Siliprandi & C. Dose & C. Riccardi & M. Porto, 2008. "Fluctuations of company yearly profits versus scaled revenue: Fat tail distribution of Levy type," Papers 0811.3885, arXiv.org.

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