An Analysis of Financial Analysts Optimism in Long-term Growth Forecasts

Byunghwan Lee, John OBrien and K. Sivaramakrishnan

No 2004-07, GSIA Working Papers from Carnegie Mellon University, Tepper School of Business

Abstract: Evidence suggests that long-term EPS growth forecasts of financial analysts are by and large optimistic. In particular, we test whether the Availability Heuristic (Tversky and Kahneman 1973) is descriptive of analysts’ forecasting behavior, and whether this heuristic can help explain the nature of optimism in growth forecasts. The Availability Heuristic predicts differential processing of information about current versus terminal economic conditions. Specifically, analysts’ forecasts will systematically underestimate (overestimate) growth in contraction (expansion) periods. Our results confirm this prediction. We find strong evidence of a negative association between past growth and realized forecast errors which varies across business cycles in a predictable manner. Following Chan et al (2003), we estimate a growth forecasting model, adjusting for the effects of the Availability Heuristic and business cycle. We find that under these conditions analysts’ long-term growth forecasts show significant explanatory power.

Date: 2004-12
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