We revisit LaPorta’s (1996) finding that returns on stocks with the most optimistic analyst long-term earnings growth forecasts are lower than those for stocks with the most pessimistic forecasts. We document the joint dynamics of fundamentals, expectations, and returns of these portfolios, and explain the facts using a model of belief formation based on the representativeness heuristic. Analysts forecast fundamentals from observed earnings growth, but overreact to news by exaggerating the probability of states that have become objectively more likely. We find supportive evidence for the model’s distinctive predictions. An estimation of the model quantitatively accounts for the key patterns.
Pedro, Bordalo, Gennaioli, Nicola, La Porta, Rafael, et al.,
"Diagnostic Expectations and Stock Returns"
(2018).
Open Publications at Brown.
Brown Digital Repository. Brown University Library.
https://doi.org/10.26300/5vj6-9039
This collection contains public access and open access versions of scholarly publications authored and deposited by Brown University scholars, including faculty publications in compliance with the Brown Faculty Open Access Policy
Faculty and student publications include open access articles and …
