8 interestingly they also report a negative relation

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8 Interestingly, they also report a negative relation between the current month’s change in dispersion and returns in the prior month ( t - 1) and in the subsequent month ( t + 1). In fact, their strongest association is found when returns are measured in month t + 1, which is consistent with a delayed market response that is predicted by the market friction hypothesis . Thus, the results of their study do not provide unambiguous conclusions with respect to the various theories. Barron et al. ( 2006 ) replicate the tests in L’Her and Suret ( 1996 ) for a sample of U.S. firms. They find a negative relation between changes in dispersion and stock returns over a 30-day period beginning 1 day following the earnings announcement. However, these tests do not speak to the contemporaneous relation between equity returns and dispersion of beliefs. Clement et al. ( 2003 ) investigate the market’s reaction to management earnings forecasts that corroborate analysts’ expectations. They find a positive market response to a corroborating management forecast even when the consensus analyst forecast is unchanged. This result is consistent with the cost of capital hypothesis . Our tests differ from Clement et al. ( 2003 ) in that we focus on the market reaction to the announcement of actual earnings rather than management’s forecast of earnings. Diether et al. ( 2002 ) find evidence in support of the market friction hypothesis . They find that firms with high levels of forecast dispersion earn relatively lower future returns. This is consistent with the notion that when differences in opinion about a stock are large (as represented by high forecast dispersion), investors with lowest valuations will not trade due to short sales constraints. In this case, current prices reflect the most optimistic views leading to lower future returns. Thus, rather 7 Our proxy for the change in dispersion of investor beliefs is the change in analyst forecast dispersion. Therefore, the literature we review is focused on those studies that examine the stock price effects of this same variable. 8 Specifically, they do not find evidence of a negative relation when they use the market model instead of the CAPM to estimate monthly returns. Also, they do not document statistical significance for this relation when the sample is limited to firms followed by 12 or more analysts, a scenario where one would expect to obtain greater power due to the mitigation of measurement error in forecast dispersion. 6 L. Rees, W. Thomas 123
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than discounting dispersion in beliefs, this market friction interpretation suggests investors pay a premium. Consistent with the equity call option hypothesis , prior research shows that the sensitivity of prices to earnings information decreases as profitability decreases (e.g., Hayn 1995 ; Burgstahler and Dichev 1997b ; Barth et al. 1998 ; Collins et al.
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