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Active Portfolio Management, Implied Expected Returns, and Analyst Optimism

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  • Olaf Stotz

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Abstract

This paper investigates whether implied expected returns based on the approach of CLAUS/THOMAS (2001) can be implemented in active portfolio management. This approach uses analysts' forecasts to derive return expectations by equating the present value of expected cash-flows to the current market price. It is found that active investment strategies which maximize implied expected returns significantly outperform a passive index investment. A significant part of this outperformance can be explained by the difference between the implied expected return and the return expectation justified by the CAPM. The empirical results suggest that a substantial part of this difference can be attributed to an optimism bias in analysts' forecasts. Copyright Swiss Society for Financial Market Research 2005

Suggested Citation

  • Olaf Stotz, 2005. "Active Portfolio Management, Implied Expected Returns, and Analyst Optimism," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 19(3), pages 261-275, October.
  • Handle: RePEc:kap:fmktpm:v:19:y:2005:i:3:p:261-275
    DOI: 10.1007/s11408-005-4694-0
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    References listed on IDEAS

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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 427-465, June.
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    3. Jacob, John & Lys, Thomas Z. & Neale, Margaret A., 1999. "Expertise in forecasting performance of security analysts," Journal of Accounting and Economics, Elsevier, vol. 28(1), pages 51-82, November.
    4. Michaely, Roni & Womack, Kent L, 1999. "Conflict of Interest and the Credibility of Underwriter Analyst Recommendations," Review of Financial Studies, Society for Financial Studies, vol. 12(4), pages 653-686.
    5. Peter Easton, 2002. "Using Forecasts of Earnings to Simultaneously Estimate Growth and the Rate of Return on Equity Investment," Journal of Accounting Research, Wiley Blackwell, vol. 40(3), pages 657-676, June.
    6. Fama, Eugene F & French, Kenneth R, 1996. " Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March.
    7. Harrison Hong & Jeffrey D. Kubik, 2003. "Analyzing the Analysts: Career Concerns and Biased Earnings Forecasts," Journal of Finance, American Finance Association, vol. 58(1), pages 313-351, February.
    8. John C. Easterwood & Stacey R. Nutt, 1999. "Inefficiency in Analysts' Earnings Forecasts: Systematic Misreaction or Systematic Optimism?," Journal of Finance, American Finance Association, vol. 54(5), pages 1777-1797, October.
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    Cited by:

    1. Alexander Kerl & Oscar Stolper & Andreas Walter, 2012. "Tagging the triggers: an empirical analysis of information events prompting sell-side analyst reports," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 26(2), pages 217-246, June.
    2. Breuer, Wolfgang & Feilke, Franziska & Gürtler, Marc, 2007. "Analysts' dividend forecasts, portfolio selection, and market risk premia," Working Papers FW25V2, Technische Universität Braunschweig, Institute of Finance.
    3. Florian Esterer & David Schröder, 2014. "Implied cost of capital investment strategies: evidence from international stock markets," Annals of Finance, Springer, vol. 10(2), pages 171-195, May.
    4. Stefan Kanne & Jan Klobucnik & Daniel Kreutzmann & Soenke Sievers, 2012. "To buy or not to buy? The value of contradictory analyst signals," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 26(4), pages 405-428, December.

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