A rational analysis of analyst behavior predicts that analysts immediately and without bias incorporate information into their forecasts. Several studies document analysts' tendency to systematically underreact to information. Underreaction is inconsistent with rationality. Other studies indicate that analysts systematically overreact to new information or that they are systematically optimistic. This study discriminates between these three hypotheses by examining the interaction between the nature of information and the type of reaction by analysts. The evidence indicates that analysts underreact to negative information, but overreact to positive information. These results are consistent with systematic optimism in response to information. THE LITERATURE ON F INANCIAL ANALYSTS defines the phrase "forecast inefficiency" to mean forecasts that fail to accurately incorporate new information on a timely basis and0or that are biased. These forecasts have also been described as irrational or suboptimal. Prior studies report inefficiency in analysts' forecasts, finding that they are upwardly biased and inaccurately ref lect available information. Some studies conclude from this that analysts underreact to information; other studies conclude that analysts overreact. If markets treat analysts' forecasts as both rational and statistically optimal, then inefficient forecasts could have important implications for the efficiency of pricing in securities markets. In this paper, we reexamine the apparent tendency of analysts to misinterpret earnings information. The intent of this study is to discriminate between three hypotheses:~1! that analysts systematically underreact to new earnings information;~2! that analysts systematically overreact to new earnings information; and~3! that analysts are systematically optimistic in their reactions.For hypotheses~1! and~2!, the direction of the misinterpretation~i.e., underor overreaction! is independent of the nature of the information received. In contrast, hypothesis~3! predicts that analysts are optimistic in interpreting

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