Analysts' Interim Earnings Forecasts: Evidence on the Forecasting Process

Abstract

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org.. Wiley and Accounting Research Center, Booth School of Business, University of Chicago are collaborating with JSTOR to digitize, preserve and extend access to Journal of Accounting Research. Existing empirical evidence indicates that analyst forecasts of corporate earnings do not meet the strict rationality standards prescribed by econometric tests of the rational expectations hypothesis.1 In this paper, we address the question of whether the expectation formation process underlying analyst forecasts is adaptive, or whether these forecasts are influenced by noninformational factors, such as incentives arising from the market for their forecasts (O'Brien [1988], Lin and McNichols [1993], Francis and Philbrick [1993], and Dugar and Nathan [1992]), and interaction between judgmental and/or statistical forecasting methods (Bunn and Wright [1991], Fan [1990], and Hoerl and Kennard [1970]).The rejection of rational expectations gives rise to two views of the forecasting process of analysts. The first, based on an informational argument, is that the forecasting process is adaptive (Marcet and Sargent *Carnegie Mellon University. We thank Andrew Alford, Larry Brown, Ravi Bhushan, Rick Green, Paul Healy, Shyam Sunder, and workshop participants at Carnegie Mellon University, M.I.T., SUNY at Buffalo, and the 1992 annual American Accounting Association meetings in Washington, D.C. The last author gratefully acknowledges the KPMG Peat Marwick Research Fellowship. 1 In particular, (i) analysts on average overestimate earnings (Fried and Givoly [1985], O'Brien [1988], and Abarbanell [1991]), and (ii) analyst forecasts appear to be inefficient relative to the information sets used to generate the forecasts (Klein [1990], Abarbanell [1991], and Lys and Sohn [1990]). However, Givoly [1985] reports that analyst forecasts exhibit properties implied by rationality. 103

We expect stocks to rise, but we do not know when and which ones: Excessive optimism in predicting future stock indices returns

“…This pattern was observed in the whole sample, but also in all three groups separately. We may conclude that our results do not support suggestions about the positive relationship between forecasted horizon and excessive optimism (Kang, O'Brien, & Sivaramakrishnan, 1994;Ramnath, Rock, & Shane, 2008). They do not even support previous empirical findings of Toshino and Suto (2004).…”

“…Based on our analyses of research studies on this topic to date, it seems that this phenomenon was largely not observed. We found only two other pieces of evidence supporting a positive relation between optimism and forecast horizon in the works of Kang, O'Brien, and Sivaramakrishnan (1994) and Ramnath, Rock, and Shane (2008), although they also lack the theoretical explanation of this phenomenon.…”

“…Based on previous findings (Hwang, Jan, & Basu, 1996;Brown, 1998;Mande, Wohar, & Ortman, 2003) we hypothesized that excessive optimism occurs more when predicting future returns of indices reporting profits than indices reporting losses. Finally, a few authors (Toshino & Suto, 2004;Kang, O'Brien, & Sivaramakrishnan, 1994;Ramnath, Rock, & Shane, 2008) suggested that there is a positive relationship between excessive optimism and forecasted horizon. As we stated before, there is a lack of empirical research in this area.…”

Are Risk Averse Agents More Optimistic? A Bayesian Estimation Approach

“…Previous work related to this issue include psychological surveys as well as empirical studies on professionals' economic forecasts (see, e.g., Fried and Givoly, 1982, O'Brien, 1988, Francis and Philbrick, 1993, Kang et al, 1994, Dreman and Berry, 1995, Giordani and Söderlind, 2005.…”

Inefficiency in Earnings Forecasts: Experimental Evidence of Reactions to Positive vs. Negative Information

“…Fried and Givoly (1982), O'Brien (1988), Francis and Philbrick (1993), Kang, O'Brien, and Sivaramakrishnan (1994), and Dreman and Berry (1995) provide evidence that analysts' forecasts are overly optimistic.…”