Analyst Self-Confidence and Forecast Rationality

Abstract

This paper investigates the bias and over- or under-reaction to previous years earnings using data from years between 1988 and 2005. The purpose is to study the effect of analysts' recommendations on these issues. In most of the previous literature it has been found that there is a positive bias in analyst's forecasts, and that they over-react to previous earnings changes. In this study, it is hypothesized that analysts' self-confidence can be seen in the accuracy of the forecasts. Self-confidence is measured with whether an analyst gives a clear recommendation (strong buy, buy, underperform, sell) or not. It is hypothesized that analysts' self-confidence can be seen in the accuracy of the forecasts. If an analyst is confident of his or her forecast, he or she would be more willing to give a recommendation on the company under investigation. First, it is found that the forecasts are overly optimistic in average, and that there is clear over-reaction to previous earnings changes. This is in accordance to previous studies. Second, according to the results, the optimism is greater for those forecasts that are equipped with a recommendation, but, the over-reaction is greater for the forecasts that are not equipped with any recommendation.