Bank Earnings Forecasts, Risk and the Crisis

Abstract

This paper explores the ability of financial analysts to gauge the risk taken by banks and investigates the impact of the recent financial crisis. Using a sample of 36,343 analyst forecasts issued for 411 European banks over 2003-2009 we find that analyst forecasts are influenced by risk, the type of forecaster (optimistic or pessimistic) and vary over time. Optimistic analyst forecasts are significantly influenced by insolvency, market and credit risk over the acute-crisis period (July 2007 to March 2009) resulting in larger forecast errors. Of our risk indicators only credit risk (5-year CDS spreads) significantly influences analyst forecasts pre- and during the crisis period - higher levels of credit risk are reflected in less accurate forecasts. Leverage is negatively linked to forecast error as is market volatility which has a differential impact on forecasts over time. As analyst forecasts respond to different types of risk in a varying manner this questions the role of analysts in the market discipline process.