The Value of Adjusting the Bias in Recommendations: International Evidence

Abstract

"The financial literature has shown that both earnings forecasts and investment recommendations are optimistically biased. However, while the bias in earnings forecasts has decreased over time and even some recent studies show that they are no longer optimistic, in the case of investment recommendations this bias still remains relatively constant over time. Therefore, it seems that recommendations are less credible to investors than earnings forecasts. The vast majority of recommendation studies have been carried out at the country level. In this paper, we use an international context to study whether profitable investment strategies exist when adjusting the recommendation bias of each analysed country. The adjustment we propose to correct this bias takes into account the differences across countries, and also varies in time to correct for the changes in bias over time within countries. Our empirical results show that there are in fact significant differences in the level of bias among countries, with the US and the UK being the countries with the highest bias. Second, the adjusted consensus portfolios are more orthogonal to typical investment styles (size, book-to-market and attention) and we find that investors could implement a higher number of profitable investment strategies using this adjusted measure. In this line, the results show that the countries with the lowest bias obtain the highest risk adjusted abnormal returns. Third, our work entails a practical implication, as it shows the value embedded in a simple necessary adjustment in the global asset management context. This is an important result showing that profitable investment strategies exist when considering a global portfolio based on adjusted recommendations." Copyright (c) 2007 The Authors Journal compilation (c) 2007 Blackwell Publishing Ltd.

Value of Analysts’ Consensus Recommendations and Investor Sentiment

“…On average, the number of buy recommendations is around 2.79 times that of sell recommendations. These results are close to those obtained by Lee et al [2004], Jegadeesh and Kim [2006], and Balboa et al [2009], and show the tendency of analysts to issue more positive than negative recommendations.…”

“…Finally, Balboa et al [2008Balboa et al [ , 2009) explore eight developed stock markets. The first paper documents that sell recommendations seem to be much more useful for providing significant positive returns.…”

“…On the other hand, it is also clearly established that analysts are inclined to give more buying than selling recommendations. An extensive literature has focused on the investment value of analysts' stock recommendations revealing two complementary strands of research: first, studies that examine whether investors can profit from investment strategies involving consensus recommendations and changes in analysts' recommendations (Womack [1996], Barber et al [2001Barber et al [ , 2003, Balboa et al [2008Balboa et al [ , 2009), and second, authors who have analyzed the relationship between the characteristics of recommended companies and their value, both consensus recommendations, and their changes (Jegadeesh et al [2004], Azzi et al [2006]). …”

“…2 In fact, Kolasinski [2006] shows that this bias, far from disappearing, has even increased in recent years due to the indirect effect of the regulation itself on the activity of financial analysts. In this context, the value of the recommendations has been the subject of various studies, primarily in the U.S. market, with mixed results (Barber et al [2001], Jegadeesh et al [2004], Jegadeesh and Kim [2006], and Balboa et al [2008Balboa et al [ , 2009). However, the possible relationship between the level of consensus recommendations and investor sentiment, as far as we know, has only been studied in Hribar and McInnis [2012] and Bagnoli et al [2009], and both focused on the U.S. market.…”

The Regulatory Effect on the Performance of Financial Analysts: Time Series from Two Different Legal Systems

“…Balboa et al [41] indicate that strong shareholder protection countries exhibit bias in stock recommendations due to the dispersed ownership, but not in earnings forecasts. In a context with shifting shareholder protection, we would first expect to see a higher demand for private information and thus a positive bias on the part of analysts, but as corporate governance rules strengthen we would anticipate a negative bias.…”