Earning Forecast-Based Return Predictions: Risk Proxies in Disguise?

Le (Emily) Xu
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Le (Emily) Xu: Whittmore School of Business and Economics, University of New Hampshire, Durham, NH 03824, USA

Chapter 7 in Advances in Quantitative Analysis of Finance and Accounting, 2007, pp 141-161 from World Scientific Publishing Co. Pte. Ltd.

Abstract: AbstractThis paper explores a new approach to evaluate the likelihood that omitted risk factors or market mispricing underlies the anomalous security returns to price-scaled analysts’ forecasts of earnings investigated by Elgers, Lo, and Pfeiffer (2001). This approach is to reduce measurement errors by incorporating predictable errors in analysts’ earnings forecasts and used the adjusted forecasts to evaluate the underlying phenomenon. Under the explanation of market mispricing, the price-scaled adjusted analysts’ forecasts are expected to generate greater hedge portfolio returns as the adjusted forecasts with less measure errors reduce the noise embedded in the relation of price-scaled analyst forecasts of earnings to subsequent abnormal returns. The results show that the adjusted forecasts do not enable improvements in the abnormal security returns resulting from the trading strategy. The inability to show improvements is inconsistent with the interpretation of market mispricing. Therefore, it provides indirect support for the interpretation of omitted risk factors.

Keywords: Monte Carlo Simulations; REIT; IPO; Fractional Integration; Seasonality; Long Memory; Macroeconomic Shocks; VAR; Interest Rates (search for similar items in EconPapers)
Date: 2007
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