An empirical examination of the dispersion and accuracy of analyst forecasts surrounding option listing

Abstract

Prior theoretical and empirical research indicates that option trading enhances the availability and timeliness of market information, and that the market's earnings expectation (belief) is influenced by characteristics of the information environment. Motivated by these research findings, we investigate whether option listing is associated with changes in the market's expectations about future earnings. Assuming that the distribution of analysts' earnings forecasts serves as a proxy for the market's earnings expectations and using I/B/E/S consensus analyst forecasts, we examine two properties of analyst forecasts: accuracy and dispersion. The results indicate that consensus analyst forecast accuracy improves after option listing and that the variability of analyst forecasts increases after option listing. The accuracy and dispersion results are somewhat weaker but still present after controlling for firm size and analyst following.This study provides empirical evidence regarding the relations among option trading and analyst forecast accuracy and dispersion. Extant research suggests that option trading is associated with a broader and richer information set about a firm's activities, and that the market's earnings expectation (belief) is influenced by the firm's information environment. Motivated by prior research findings, we investigate whether option trading is associated with changes in the market's expectations about future earnings (e.g., investors and financial analysts may use the increased

Options Trading and the Extent that Stock Prices Lead Future Earnings Information

“…These desirable features attract informed traders to act on their private information in the options market, which in turn impounds such information into the equity market (Black, 1975;Manaster and Rendleman, 1982;Biais and Hillion, 1992;Back, 1993;and Mayhew et al, 1995). Empirical evidence supporting this view includes a speedier stock price adjustment to earnings announcements for optioned firms than for non-optioned firms (Jennings and Stark, 1986;Skinner, 1990;and Ho, 1993) and findings that options trading releases private information into the equity market before earnings announcements (Amin and Lee, 1997;and Zhang et al, 2009) and before takeover announcements (Cao et al, 2005).…”

“…Several studies suggest that when options trading is introduced for a firm, the firm's information environment becomes significantly richer. Following an options listing, firms attract a higher number of analysts, a higher level of institutional ownership, and more coverage in the financial media (Skinner, 1989 and; Damodaran and Lim, 1991;Ho, 1993;and Ho et al, 1995). TRUONG for at least two reasons.…”

“…First, this framework employs stock returns over a longterm period (yearly and multi-year periods) and places accounting earnings as a major source of information that drives stock prices over time. Most prior studies focus on the relation between options trading and the instant assimilation of current earnings information into current stock prices (e.g., Skinner, 1990;and Ho, 1993) over a short-term window and hence their research findings are mostly specific to earnings announcements. The research findings in this study, by contrast, can be generalized over a much broader time period.…”

“…7 7 Ho et al (1995) demonstrate that analyst forecast accuracy improves significantly following an options listing. They conclude that options trading enhances the timeliness and availability of market expectations.…”

“…5 5 Skinner (1990) and Ho et al (1995) find that both the quantity and quality of information available for investors increase significantly following an options listing. …”