Fantastic Review of Analyst Forecast Research

If you do research in analyst forecasts, this one;s a must read: The Financial Analyst Forecasting Literature: A Taxonomy with Suggestions for Further Research by Sundaresh Ramnath, Steve Rock, and Philip Shane in the International journal of Forecasting (2008)

Here's the abstract:

This paper develops a taxonomy of research examining the role of financial analysts in capital markets. The paper builds on the perspectives provided by Schipper [Schipper, K. (1991). Analysts' forecasts. Accounting Horizons, 5, 105-131] and Brown [Brown, L. (1993). Earnings forecasting research: Its implications for capital markets research. International Journal of Forecasting, 9, 295-320]. We categorize papers published since 1992, describe the research questions addressed, and suggest avenues for further research in seven broad areas: (1) analysts' decision processes; (2) the nature of analyst expertise and the distributions of earnings forecasts; (3) the information content of analyst research; (4) analyst and market efficiency; (5) analysts' incentives and behavioral biases; (6) the effects of the institutional and regulatory environment (including cross-country comparisons); and (7) research design issues.

Note: although it's a forthcoming paper, there's a downloadable version available from SSRN here.

Lake Wobegon Stock Recommendations

It's pretty well known that "Sell" recommendations on Wall Street are about as rare as honest politicians in Washington (they're out there, but don't expect to find a lot of them).

It seems like Merrill Lynch is trying to change its ways. They have a new standard for their analysts - Beginning in June, they will require that its analysts assign “underperform” ratings to 20% of all stocks they cover (currently, only 12% of covered stocks fall into that category). Their hope is that the new standard will make their recommendations more credible, since a "buy" will no longer be the default evaluation.

A similar movement is going on in academia. A number of schools (the Unknown Alma Mater among them) have put limitations on grade distributions (i.e. there's a maximum percentage of A's and B's that an instructor can assign). It's not as much of a problem in the Finance and Accounting areas, since we're generally tougher graders than those in the Liberal Arts areas. I'm not aware of how things are done in other areas, but Business Schools have been moving in this direction for a couple of years now. It may be one of the few cases where academia has actually moved faster than the business world. I guess even a stopped clock shows the right time a couple times a day.

Read the whole thing here.

A Great Review of Analyst Forecast Research

As most academics know, a good survey article is worth its weight in gold. So, here's a good one on analyst forecast research (you can send money later)

Sundaresh Ramnath, Steve Rock and Philip Shane have a piece in the 2008 International Journal Of Forecasting entitled "The Financial Analyst Forecasting Literature: A Taxonomy with Suggestions for Further Research." In it, they catalog and organize about 250 research articles on various facets of the equity analysis process done since 1992 (it builds on earlier pieces by Schipper (991) and Brown (1993)). They arrange their review into the following topics:

• How do analysts make decisions (i.e. what information do they use, how does their environment affect them, etc...)
• What is the nature of analysts expertise (i.e. how do you measure it, is there herding, etc...)
• Information content (how informative are analysts forecasts, is there information in forecasts over an above other available information)
• Market efficiency (how much is extant information reflected in forecasts, do stock prices reflect the info in forecasts, etc...)
• What incentives or behavioral biases affect or are present in analyst forecasts
• How does the regulatory environment affect the forecasting process
• How statistically valid are analyst forecast studies?
  

All in all, it's a very thorough piece, and I suspect it'll end up being read and cited by quite academics. In particular, I'd recommend it to grad students who are trying to get up to speed on this very broad literature.

The IJF piece is for subscribers only, but there's an ungated version on SSRN here.

HT: CXO Advisory Group.