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A Catering Theory of Analyst Bias

  • Lai, Richard

We posit a theory that runs counter to how conventional wisdom thinks about analyst bias, that it is the result of distorted incentives by "the system" - especially upstream factors like the analysts' employers. We suggest that analysts are also heavily influenced by what investors believe, 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 they believe. 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 hold. Further, we employ a vector-autoregressive model to show Granger - causality between the two.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 4761.

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Date of creation: 24 May 2004
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Handle: RePEc:pra:mprapa:4761
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  1. Sendhil Mullainathan & Andrei Shleifer, 2005. "The Market for News," American Economic Review, American Economic Association, vol. 95(4), pages 1031-1053, September.
  2. Malcolm Baker & Jeffrey Wurgler, 2003. "A Catering Theory of Dividends," NBER Working Papers 9542, National Bureau of Economic Research, Inc.
  3. 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, 02.
  4. Jeffrey A. Wurgler & Malcolm P. Baker, 2001. "Market Timing and Capital Structure," Yale School of Management Working Papers ysm181, Yale School of Management.
  5. Grinblatt, Mark & Titman, Sheridan & Wermers, Russ, 1995. "Momentum Investment Strategies, Portfolio Performance, and Herding: A Study of Mutual Fund Behavior," American Economic Review, American Economic Association, vol. 85(5), pages 1088-1105, December.
  6. Daniel Kahneman, 2003. "A Psychological Perspective on Economics," American Economic Review, American Economic Association, vol. 93(2), pages 162-168, May.
  7. Shleifer, Andrei & Vishny, Robert W., 2003. "Stock market driven acquisitions," Journal of Financial Economics, Elsevier, vol. 70(3), pages 295-311, December.
  8. Karl B. Diether & Christopher J. Malloy & Anna Scherbina, 2002. "Differences of Opinion and the Cross Section of Stock Returns," Journal of Finance, American Finance Association, vol. 57(5), pages 2113-2141, October.
  9. John R. Graham, 1999. "Herding among Investment Newsletters: Theory and Evidence," Journal of Finance, American Finance Association, vol. 54(1), pages 237-268, 02.
  10. Mastrapasqua, Frank & Bolten, Steven, 1973. "A Note on Financial Analyst Evaluation," Journal of Finance, American Finance Association, vol. 28(3), pages 707-12, June.
  11. Brown, Lawrence D & Rozeff, Michael S, 1978. "The Superiority of Analyst Forecasts as Measures of Expectations: Evidence from Earnings," Journal of Finance, American Finance Association, vol. 33(1), pages 1-16, March.
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