A Catering Theory of Analyst Bias
AbstractWe posit a theory that runs counter to how conventional wisdom thinks about analyst bias, that it is the result of distorted incentives by “upstream” factors like the analysts’ employers. We suggest that analysts are also heavily influenced by the beliefs of investors downstream, the purported victims of analyst bias. We adapt Mullainathan-Shleifer’s theory of media bias to build a theory of how analysts cater to what investors believe. The theory also predicts that competition among analysts does not reduce their bias. We provide empirical support for this theory, using an enormous dataset built from over 6.5 million analyst estimates and 42.8 million observations on investor holdings, which we argue is a proxy for what investors’ beliefs. We use a simultaneous-equations model for estimation, with instruments to rule out alternative interpretations of the direction of causality. For additional robustness, we investigate the time series of analyst bias and heterogeneity in investor beliefs from 1987 through 2003. Dickey-Fuller tests show that both have unit roots, but we establish that cointegration holds. Further, we employ a vector- autoregressive model to show Granger-causality between the two.
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Bibliographic InfoPaper provided by EconWPA in its series Finance with number 0509004.
Length: 99 pages
Date of creation: 04 Sep 2005
Date of revision:
Note: Type of Document - pdf; pages: 99
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Analyst bias; behavioral finance; media bias;
Other versions of this item:
- G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
- G20 - Financial Economics - - Financial Institutions and Services - - - General
- G39 - Financial Economics - - Corporate Finance and Governance - - - Other
This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-11-09 (All new papers)
- NEP-CBE-2005-11-09 (Cognitive & Behavioural Economics)
- NEP-FIN-2005-11-09 (Finance)
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