Existence and Exploitability of Financial Analysts' Informational Leadership

Rainer Baule, Hannes Wilke

Abstract

This paper bridges two recent studies on the role of analysts to provide new and relevant information to investors. On the one hand, the contribution of analysts to long-term price discovery on the US market is rather low. Considering earnings per share forecasts as the main output of analysts’ reports, their information share amounts to only 4.6% on average. On the other hand, trading strategies set up on these EPS forecasts are quite profitable. Self-financing portfolios yield excess returns of more than 5% over the S&P 100 index for a time period of 36 years, which is persistent after controlling for the well-known risk factors. In this paper, we discuss the link between the low information shares and the high abnormal returns. We argue that information shares of analysts cannot be higher, because otherwise their forecasts would lead to excessively profitable trading strategies which are very unlikely to persist over such a long period of time.

Keywords

Analysts; Informational Leadership; Information shares; Self-financing Trading Strategies

Full Text:

PDF

References

Baule, R., Wilke, H., 2016. Of leaders and followers – An econometric analysis of equity analysts and stock market investors. Working Paper, University of Hagen.

Baule, R., Wilke, H., 2015. To follow or not to follow – An analysis of the profitability of portfolio strategies based on analyst consensus EPS forecasts. Working Paper, University of Hagen.

Carhart, M.M., 1997. On persistence in mutual fund performance. Journal of Finance 52, 57–82.

Fama, E.F., 1970. Efficient capital markets: A review of theory and empirical work. Journal of Finance 25, 383–417.

Fama, E.F., French, K.R., 1993. Common risk factors in the returns of stocks and bonds. Journal of Financial Economics 33, 3–56.

Fama, E. F., French, K.R., 2015. A five-factor asset pricing model, Journal of Financial Economics 116, 1–22.

Hasbrouck, J., 1995. One security, many markets: Determining the contributions to price discovery. Journal of Finance 50, 1175–1199.

Wilke, H., 2016. Die Bedeutung von Finanzanalysten auf entwickelten Kapitalmärkten. BWV, Berlin.