Irrational Analysts' Expectations as a Cause of Excess Volatility in Stock Prices
AbstractThis paper investigates whether excess stock price volatility may be due in part to a failure of the market to form rational expectations. Using data on analysts' expectations of long run earnings growth for individual companies, we report a number of interelated results which lend support to this hypothesis. First we show that there is no statistically significant relationship between analysts' long run forecasts and subsequent earnings growth, suggesting that analysts' earnings expectations are excessively dispersed. Secondly, we provide evidence that analysts' expectations are reflected in market prices. These two results together imply that the cross-section of stock prices will also be excessively dispersed, so that stocks with low earnings expectations are underpriced and stocks with high earnings expectations are overpriced. As analysts' forecasts errors become apparent, stock prices should adjust accordingly and so excess returns should accrue. We demonstrate that analysts' forecasts are indeed negatively correlated with subsequent excess returns. All hypothesis testing uses panel regression techniques, and to circumvent the problem of cross-sectional dependence in the data we use a generalised method of moments estimator of the parameter covariance matrix.
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Bibliographic InfoPaper provided by Exeter University, Department of Economics in its series Discussion Papers with number 9608.
Date of creation: 1996
Date of revision:
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Volatility; Earnings expectations; Panel data;
Other versions of this item:
- Bulkley, George & Harris, Richard D F, 1997. "Irrational Analysts' Expectations as a Cause of Excess Volatility in Stock Prices," Economic Journal, Royal Economic Society, vol. 107(441), pages 359-71, March.
- C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
- D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
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- George Buckley & Richard Holt, 2004. "Forecasting Cross-Section Stock Returns using Theoretical Prices Estimated from an Econometric Model," ESE Discussion Papers 47, Edinburgh School of Economics, University of Edinburgh.
- Martin Wallmeier, 2005. "Analysts’ Earnings Forecasts for DAX100 Firms During the Stock Market Boom of the 1990s," Financial Markets and Portfolio Management, Springer, vol. 19(2), pages 131-151, August.
- Andreas Fuster & Benjamin Hebert & David Laibson, 2011.
"Natural Expectations, Macroeconomic Dynamics, and Asset Pricing,"
in: NBER Macroeconomics Annual 2011, Volume 26, pages 1-48
National Bureau of Economic Research, Inc.
- Andreas Fuster & Benjamin Hebert & David Laibson, 2012. "Natural Expectations, Macroeconomic Dynamics, and Asset Pricing," NBER Macroeconomics Annual, University of Chicago Press, vol. 26(1), pages 1 - 48.
- Andreas Fuster & Benjamin Hebert & David Laibson, 2011. "Natural Expectations, Macroeconomic Dynamics, and Asset Pricing," NBER Working Papers 17301, National Bureau of Economic Research, Inc.
- Gordon Burt, 1997. "Cultural Convergence in Historical Cultural Space-Time," Journal of Cultural Economics, Springer, vol. 21(4), pages 291-305, December.
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