On the Determinants of Optimism in Financial Analyst Earnings Forecasts: The Effect of the Market's Ability to Adjust for the Bias


  • This paper is based on a part of my dissertation completed at Penn State University. I am indebted to the members of my dissertation committee, Anne Beatty, Ed Coulson, Frank Hatheway and especially Jim McKeown (chair) for their insightful comments. This paper has also benefited from the comments of Orie Barron, Afshad Irani, Jana Raedy, Kevin Raedy, Phil Shane, Philip Stocken, Ram Venkataraman, Joe Weber, and workshop participants at Penn State and the University of Cyprus. The excellent research assistance of Michalis Makris is greatly appreciated. I also gratefully acknowledge the contribution of I/B/E/S International Inc. for providing analyst forecast data. These data have been provided as part of a broad academic program to encourage earnings expectations research. A list of firms in the sample is available from the author on request. All other data are available from public sources identified in the text.

Irene Karamanou (Irene.Karamanou@ucy.ac.cy) is an Assistant Professor in the Department of Public and Business Administration, University of Cyprus.


This paper examines whether the documented bias in analyst earnings forecasts is intentional by examining whether it is related to the market's ability to adjust for this bias. For intentional bias to exist it is not enough for analysts to face incentives but rather, analysts should also be willing to respond to these incentives. As the market's ability to adjust for the bias increases, its market effects decrease while analyst reputation costs increase reducing analyst willingness to bias their forecasts. The paper utilizes a firm-specific design that allows for both the bias component of the forecast error and the market's ability to adjust for the bias to be computed at the firm level. Results suggest that even though forecast error is positive in the latter part of the period under review reflecting overall analyst pessimism, the bias embedded in the forecasts is optimistic throughout the period. More importantly, I find that analyst forecast bias is decreasing in the market's ability to adjust for it. This result provides further evidence that analysts knowingly bias their forecasts and provides support for the existence of reporting bias, in particular. Thus, the evidence provides justification for recent regulatory efforts to increase the objectivity of analyst research reports.