Dispersion in analysts’ earnings forecasts and credit rating |
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Authors: | Doron Avramov Tarun Chordia Gergana Jostova Alexander Philipov |
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Affiliation: | 1. Department of Finance, Robert H. Smith School of Business, University of Maryland, College Park, MD 20742, USA;2. Department of Finance, Goizueta Business School, Emory University, Atlanta, GA 30322, USA;3. Department of Finance, School of Business, George Washington University, Funger Hall Suite 501, 2201 G Street NW, Washington, DC 20052, USA;4. Department of Finance, School of Management, George Mason University, Fairfax, VA 22030, USA |
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Abstract: | This paper shows that the puzzling negative cross-sectional relation between dispersion in analysts’ earnings forecasts and future stock returns may be explained by financial distress, as proxied by credit rating downgrades. Focusing on a sample of firms rated by Standard & Poor's (S&P), we show that the profitability of dispersion-based trading strategies concentrates in a small number of the worst-rated firms and is significant only during periods of deteriorating credit conditions. In such periods, the negative dispersion–return relation emerges as low-rated firms experience substantial price drop along with considerable increase in forecast dispersion. Moreover, even for this small universe of worst-rated firms, the dispersion–return relation is non-existent when either the dispersion measure or return is adjusted by credit risk. The results are robust to previously proposed explanations for the dispersion effect such as short-sale constraints and leverage. |
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Keywords: | G14 G12 G11 |
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