Analysts' forecast dispersion and stock returns: a panel threshold regression analysis based on conditional limited market participation hypothesis

Abstract

Prior research has investigated the association between analysts’ forecast dispersion and future stock return but the evidence is not conclusive. We propose a conditional limited market participation hypothesis and reexamine the relation between analysts’ forecast dispersion and stock returns using the panel threshold regression approach, which allows the coefficient on the independent variable to shift when the conditioned variables exceed their respective thresholds. Our empirical results show that the degree of the negative association between analysts’ dispersion and future stock return becomes considerably diminished when the dispersion exceeds a threshold value. Our finding does not support the view of Johnson (2004), [Forecast dispersion and the cross section of expected returns, J. Financ. 59, 1957–1978], that dispersion in analysts’ forecasts serves as a proxy for risk. Although our results are consistent with the limited market participation argument in Diether et al. (2002), [Differences of opinion and the cross section of stock returns, J. Financ. 57, 2113–2141], we modify their arguments as the strength of their results is conditional on the magnitude of dispersion.