Measuring Herding and Exaggeration by Equity Analysts and Other Opinion Sellers

Measuring Herding and Exaggeration by Equity Analysts and Other Opinion Sellers

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Measuring Herding and Exaggeration by Equity Analysts and Other Opinion Sellers Eric Zitzewitz & Stanford GSB 1 July 2001 JEL classi & cation: G2, D8 Keywords: Herding, Analysts, Forecasting 1 Stanford Graduate School of Business, 518 Memorial Way, Stanford, CA, 94305. Tel: 650-724-1860. Fax: 650-725-9932. Email: ericz@stanford.edu. The author would like to thank Glenn Ellison, Bengt Holmstrom, Dean Karlan, Leigh Linden, Sendhil Mullainathan, Nancy Rose, Jean Tirole, Ezra Zuckerman and seminar participants at Berkeley, Harvard, London Business School, Michigan, MIT, Northwestern, Stanford, Washington University- St. Louis, and Yale for helpful comments and suggestions. Particular thanks are due to my primary advisor, Robert Gibbons. All errors are my own. The & nancial support of an NSF Graduate Research Fellowship is gratefully acknowledged. I also thank I/B/E/S for providing me with access to their analyst data.
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Abstract Firms and individuals who sell opinions may bias their reports for either behavioral or strategic reasons. This paper proposes a methodology for measuring these bi- ases, particularly whether opinion producers under or over emphasize their private information, i.e. whether they herd or exaggerate their di f erences with the consen- sus. Applying the methodology to I/B/E/S analysts reveals that they do not herd as is often assumed, but rather they exaggerate their di f erences with the consensus by an average factor of about 2 . 4 . Analysts also overweight their prior-period pri- vate information and thus under-update based on last period&s forecast error; this under-updating helps explain the apparently con & icting over and under-reaction re- sults of DeBondt and Thaler (1990) and Abarbanell and Bernhard (1992). A useful by-product of the methodology is a measure of the incremental information content of an analyst&s forecasts. Using this measure reveals that analysts di f er greatly in performance: the information content of the future forecasts of the top 10 percent of analysts is roughly six times that of the bottom 40 percent.
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Measuring Herding and Exaggeration by Equity Analysts and Other Opinion Sellers 1 Introduction Each recent & nancial crisis has renewed concerns that & nancial market participants face incentives to underweight or even ignore their private information and herd with the existing consensus. In both & nance and general management, when a group is collectively surprised by an event, outside observers often worry that they have been practicing &group think± and herding on each other²s opinions. In practice, it is very di cult to determine whether a group has been surprised because they were herding and ignoring the warning signs or because warning signs simply were either not available or too weak to be rationally taken seriously. Nonetheless, we would like know whether herding occurs, so that consumers and organizations can adjust the way they use information or even alter contracts to diminish the incentives that foster it.
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This note was uploaded on 07/21/2011 for the course BUS 10001 taught by Professor All during the Spring '11 term at Shaheed Zulfiqar Ali Bhutto Institute of Science and Technology.

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Measuring Herding and Exaggeration by Equity Analysts and Other Opinion Sellers

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