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Dispersion in analysts' earnings forecasts and credit rating

Author

Listed:
  • Avramov, Doron
  • Chordia, Tarun
  • Jostova, Gergana
  • Philipov, Alexander

Abstract

This paper shows that the puzzling negative cross-sectional relation between dispersion in analysts' earnings forecasts and future stock returns may be explained by financial distress, as proxied by credit rating downgrades. Focusing on a sample of firms rated by Standard & Poor's (S&P), we show that the profitability of dispersion-based trading strategies concentrates in a small number of the worst-rated firms and is significant only during periods of deteriorating credit conditions. In such periods, the negative dispersion-return relation emerges as low-rated firms experience substantial price drop along with considerable increase in forecast dispersion. Moreover, even for this small universe of worst-rated firms, the dispersion-return relation is non-existent when either the dispersion measure or return is adjusted by credit risk. The results are robust to previously proposed explanations for the dispersion effect such as short-sale constraints and leverage.

Suggested Citation

  • Avramov, Doron & Chordia, Tarun & Jostova, Gergana & Philipov, Alexander, 2009. "Dispersion in analysts' earnings forecasts and credit rating," Journal of Financial Economics, Elsevier, vol. 91(1), pages 83-101, January.
    • Handle: RePEc:eee:jfinec:v:91:y:2009:i:1:p:83-101
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    References listed on IDEAS

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