Using Analysts’ Characteristics in Gauging Recommendation Optimism and the Implication for Recommendation Profitability

 
 
 
 

Using Analysts’ Characteristics in Gauging Recommendation Optimism and the Implication for Recommendation Profitability

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Title: Using Analysts’ Characteristics in Gauging Recommendation Optimism and the Implication for Recommendation Profitability
Author: Cao, Jian
Description: Prior research suggests that sell-side analysts are, on average, biased toward issuing overly optimistic “Buy” recommendations that may not accurately reflect their opinions about the values of the firms they follow. Given the widely-held claim about analyst bias, I construct a measure of analyst recommendation optimism based on both the favorableness and valuation relevance of a stock recommendation. Applying the optimism measure to a sample of the I/B/E/S detailed recommendation and forecast database over the period 1994-2004, I examine whether and how the characteristics of individual analyst are important to investors’ education about the underlying bias and value in analysts’ recommendations. I find that analysts who embody superior research attributes are less likely to provide overly optimistic recommendations deviating from fundamental valuations. I also show that investors do not recognize the full extent of the bias and investors, conscious of the low credibility of buy recommendations, rely on individual characteristics of analysts when evaluating the related bias. Finally, the evidence suggests that recent regulations on analysts’ conflicts-of-interest and qualification have enhanced the role of analyst characteristics in mitigating recommendation bias and the ability of investors to recognize the extent of the bias. The findings should have broad implications for investors, legislators, and security regulators. While Congress, regulators, and security exchanges have taken several steps to reinstill public confidence in the objectivity of analyst research, investor education is particularly vital to managing analyst risk. Evidence on how analysts incorporate their private valuations into the issued opinions could potentially assist investors in gauging the nature and value of stock recommendations and managing the related risk when they follow individual analysts’ advice.
Permanent Link: http://rave.ohiolink.edu/etdc/view?acc_num=kent1189720217
http://hdl.handle.net/2374.OX/17820
Date: 2007

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