Uncovering Expected Returns: Information in Analyst Coverage Proxies
43 Pages Posted: 27 Jan 2016 Last revised: 16 Jun 2016
Date Written: June 15, 2016
We show that analyst coverage proxies contain information about expected returns. We decompose analyst coverage into abnormal and expected components using a simple characteristic-based model and show that firms with abnormally high analyst coverage subsequently outperform firms with abnormally low coverage by approximately 80 basis points per month. We also show abnormal coverage rises following exogenous shocks to underpricing and predicts improvements in firms' fundamental performance, suggesting that return predictability stems from analysts more heavily covering underpriced stocks. Our findings highlight the usefulness of analysts' actions in expected return estimations, and a potential inference problem when coverage proxies are used to study information asymmetry and dissemination.
Keywords: expected returns, analysts, mispricing
JEL Classification: G10, G11, G12, G14, M40, M41
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