In Earning Season, Does Analyst Outlook Work?
How impartial are analyst recommendations? In a National Bureau of Economic Research (NBER) paper written last year, titled, Do Security Analysts Speak in Two Tongues?, Ulrike Malmendier of the University of California at Berkeley and Devin Shanthikumar of Harvard Business School set out to study why security analysts issue overly positive recommendations.
To the sceptical layman, there seems to be a straightforward answer—analysts are paid to encourage clients to buy stocks, simply because the universe of potential buyers is always larger than the universe of potential sellers. Malmendier and Shanthikumar, not being so cynical, consider two alternative explanations: One, analysts pick favourite stocks and are genuinely overoptimistic; and two, analysts distort recommendations to maximize commissions and underwriting business, particularly if affiliated with an underwriter.
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