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Dispersion in analysts' earnings forecasts and credit rating

  • Avramov, Doron
  • Chordia, Tarun
  • Jostova, Gergana
  • Philipov, Alexander

This paper shows that the puzzling negative cross-sectional relation between dispersion in analysts' earnings forecasts and future stock returns may be explained by financial distress, as proxied by credit rating downgrades. Focusing on a sample of firms rated by Standard & Poor's (S&P), we show that the profitability of dispersion-based trading strategies concentrates in a small number of the worst-rated firms and is significant only during periods of deteriorating credit conditions. In such periods, the negative dispersion-return relation emerges as low-rated firms experience substantial price drop along with considerable increase in forecast dispersion. Moreover, even for this small universe of worst-rated firms, the dispersion-return relation is non-existent when either the dispersion measure or return is adjusted by credit risk. The results are robust to previously proposed explanations for the dispersion effect such as short-sale constraints and leverage.

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Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 91 (2009)
Issue (Month): 1 (January)
Pages: 83-101

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Handle: RePEc:eee:jfinec:v:91:y:2009:i:1:p:83-101
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505576

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  1. Doron Avramov & Tarun Chordia & Gergana Jostova & Alexander Philipov, 2007. "Momentum and Credit Rating," Journal of Finance, American Finance Association, vol. 62(5), pages 2503-2520, October.
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  7. Hand, John R M & Holthausen, Robert W & Leftwich, Richard W, 1992. " The Effect of Bond Rating Agency Announcements on Bond and Stock Prices," Journal of Finance, American Finance Association, vol. 47(2), pages 733-52, June.
  8. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-36, May-June.
  9. Szilagyi, Jan & Hilscher, Jens & Campbell, John, 2008. "In Search of Distress Risk," Scholarly Articles 3199070, Harvard University Department of Economics.
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  12. X. Frank Zhang, 2006. "Information Uncertainty and Stock Returns," Journal of Finance, American Finance Association, vol. 61(1), pages 105-137, 02.
  13. John M. Griffin & Michael L. Lemmon, 2002. "Book-to-Market Equity, Distress Risk, and Stock Returns," Journal of Finance, American Finance Association, vol. 57(5), pages 2317-2336, October.
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