Does analyst forecast dispersion represent investors’ perceived uncertainty toward earnings?

Abstract

PurposeThis paper aims to investigate the association between analyst forecast dispersion and investors’ perceived uncertainty toward earnings.Design/methodology/approachA new measure for investors’ expectations of earnings announcement uncertainty is constructed, using changes in implied volatility of option contracts prior to earnings announcements. Unlike other proxies of uncertainty, this measure isolates the incremental uncertainty regarding the upcoming earnings announcement and is a forward-looking measure.FindingsUsing this new proxy, this paper finds a significant negative correlation between analyst forecast dispersion and investors’ uncertainty regarding the upcoming earnings announcements. Further tests show that this negative correlation is driven by analysts’ private information acquisition rather than analysts; uncertainty toward upcoming earnings announcements. Additional cross-sectional tests show that this negative relationship is more pronounced in the subsample with lower earnings quality.Social implicationsThis paper helps to further the understanding of the information content of analyst forecast dispersion, particularly the ways in which they gather and produce private information and their incentives for so doing.Originality/valueThis paper introduces a new market-based and forward-looking proxy of earnings announcement uncertainty that should be useful in future research. This paper also provides original empirical evidence that analysts gather and produce an additional private information to the market when facing noisy signals and that their information reduces investors’ uncertainty toward upcoming earnings announcements.