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Tests of Analysts' Overreaction/Underreaction to Earnings Information as an Explanation for Anomalous Stock Price Behavior

Authors

  • JEFFERY S. ABARBANELL,

  • VICTOR L. BERNARD

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    • Abarbanell is Assistant Professor of Accounting at the University of Michigan. Bernard is the Price Waterhouse Professor of Accounting at the University of Michigan. We are grateful to Jacob Thomas for supplying certain data used in this study, and to Ken French, Doug Hanna, Marilyn Johnson, Bill Lanen, Rick Mendenhall, Pat O'Brien, Krishna Palepu, Gordon Richardson, Doug Skinner, Jacob Thomas, Peter Wilson, and workshop participants at the American Finance Association meetings, the Boston Area Research Colloquium, the University of California at Berkeley, the University of Chicago, Georgetown University, the National Bureau of Economics Research, and the University of Nebraska for useful comments. Any remaining errors, however, are the responsibility of the authors.

ABSTRACT

This study examines whether security analysts underreact or overreact to prior earnings information, and whether any such behavior could explain previously documented anomalous stock price movements. We present evidence that analysts' forecasts underreact to recent earnings. This feature of the forecasts is consistent with certain properties of the naive seasonal random walk forecast that Bernard and Thomas (1990) hypothesize underlie the well-known anomalous post-earnings-announcement drift. However, the underreactions in analysts' forecasts are at most only about half as large as necessary to explain the magnitude of the drift. We also document that the “extreme” analysts' forecasts studied by DeBondt and Thaler (1990) cannot be viewed as overreactions to earnings, and are not clearly linked to the stock price overreactions discussed in DeBondt and Thaler (1985, 1987) and Chopra, Lakonishok, and Ritter (Forthcoming). We conclude that security analysts' behavior is at best only a partial explanation for stock price underreaction to earnings, and may be unrelated to stock price overreactions.

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