Uncertainty and Financial Analysts’ Overconfidence: European Evidence Between High-Tech and Low-Tech Firms

Abstract

This article examines the link between uncertainty and analysts’ reaction to earnings announcements for a sample of European firms during the period 1997-2007. In the same way as Daniel et al. (1998), we posit that overconfidence leads to an overreaction to private information followed by an undereaction when the information becomes public. Psychological findings suggest that this effect is more prominent in an uncertain environment. Our tests are based on the relationship between forecast revisions and forecast errors. When analysts excessively integrate information in their revisions (i.e. overreact), their forecast revisions are too intense, and the converse occurs when they underreact. We implement a portfolio analysis and a regression analysis for two subsamples: high-tech and low-tech, as a proxy for uncertainty. Our results support the overconfidence hypothesis. We jointly observe the two phenomena of under- and overreaction. Overreaction occurs when the information has not yet been made public and disappears just after public release. Our results also show that both effects are stronger for the high-tech subsample. For robustness, we sort the sample using analyst forecast dispersion as a proxy for uncertainty and obtain similar results. We also document that the high-tech stocks crash in 2000-2001 moderated analysts’ overconfidence.