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Forecast Accuracy Uncertainty and Momentum

  • Bing Han


    (McCombs School of Business, University of Texas at Austin, Austin, Texas 78712)

  • Dong Hong


    (Lee Kong Chian School of Business, Singapore Management University, Singapore 178899, Singapore)

  • Mitch Warachka


    (Lee Kong Chian School of Business, Singapore Management University, Singapore 178899, Singapore)

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We demonstrate that stock price momentum and earnings momentum can result from uncertainty surrounding the accuracy of cash flow forecasts. Our model has multiple information sources issuing cash flow forecasts for a stock. The investor combines these forecasts into an aggregate cash flow estimate that has minimal mean-squared forecast error. This aggregate estimate weights each cash flow forecast by the estimated accuracy of its issuer, which is obtained from their past forecast errors. Momentum arises from the investor gradually learning about the relative accuracy of the information sources and updating their weights. Empirical tests validate the model's prediction of stronger momentum in stocks with large information weight fluctuations and high forecast dispersion. We also identify return predictability attributable to changes in the information weights.

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Article provided by INFORMS in its journal Management Science.

Volume (Year): 55 (2009)
Issue (Month): 6 (June)
Pages: 1035-1046

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Handle: RePEc:inm:ormnsc:v:55:y:2009:i:6:p:1035-1046
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