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Experts' earning forecasts: bias, herding and gossamer information

  • Olivier Guedj

    (Capital Fund Management)

  • Jean-Philippe Bouchaud

    (Science & Finance, Capital Fund Management
    CEA Saclay;)

Registered author(s):

    We study the statistics of earning forecasts of US, EU, UK and JP stocks during the period 1987-2004. We confirm, on this large data set, that financial analysts are on average over-optimistic and show a pronounced herding behavior. These effects are time dependent, and were particularly strong in the early nineties and during the Internet bubble. We furthermore find that their forecast ability is, in relative terms, quite poor and comparable in quality, a year ahead, to the simplest `no change' forecast. As a result of herding, analysts agree with each other five to ten times more than with the actual result. We have shown that significant differences exist between US stocks and EU stocks, that may partly be explained as a company size effect. Interestingly, herding effects appear to be stronger in the US than in the Eurozone. Finally, we study the correlation of errors across stocks and show that significant sectorization occurs, some sectors being easier to predict than others. These results add to the list of arguments suggesting that the tenets of Efficient Market Theory are untenable.

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    Paper provided by Science & Finance, Capital Fund Management in its series Science & Finance (CFM) working paper archive with number 500062.

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    Date of creation: Oct 2004
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    Handle: RePEc:sfi:sfiwpa:500062
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    1. Fama, Eugene F, 1970. "Efficient Capital Markets: A Review of Theory and Empirical Work," Journal of Finance, American Finance Association, vol. 25(2), pages 383-417, May.
    2. De Bondt, Werner F M & Thaler, Richard, 1985. " Does the Stock Market Overreact?," Journal of Finance, American Finance Association, vol. 40(3), pages 793-805, July.
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    4. Kirman, Alan, 1993. "Ants, Rationality, and Recruitment," The Quarterly Journal of Economics, MIT Press, vol. 108(1), pages 137-56, February.
    5. Jean-Philippe Bouchaud & Yuval Gefen & Marc Potters & Matthieu Wyart, 2004. "Fluctuations and response in financial markets: the subtle nature of 'random' price changes," Quantitative Finance, Taylor & Francis Journals, vol. 4(2), pages 176-190.
    6. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
    7. Mark J. Powers, 2000. "Introduction," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 20(1), pages 3-4, 01.
    8. Terrance Odean, 1999. "Do Investors Trade Too Much?," American Economic Review, American Economic Association, vol. 89(5), pages 1279-1298, December.
    9. Wyart, Matthieu & Bouchaud, Jean-Philippe, 2007. "Self-referential behaviour, overreaction and conventions in financial markets," Journal of Economic Behavior & Organization, Elsevier, vol. 63(1), pages 1-24, May.
    10. Bikhchandani, Sushil & Hirshleifer, David & Welch, Ivo, 1992. "A Theory of Fads, Fashion, Custom, and Cultural Change in Informational Cascades," Journal of Political Economy, University of Chicago Press, vol. 100(5), pages 992-1026, October.
    11. Jean-Philippe Bouchaud & Yuval Gefen & Marc Potters & Matthieu Wyart, 2003. "Fluctuations and response in financial markets: the subtle nature of `random' price changes," Science & Finance (CFM) working paper archive 0307332, Science & Finance, Capital Fund Management.
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