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Rationality and Analysts' Forecast Bias
Author(s) -
Lim Terence
Publication year - 2001
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/0022-1082.00329
Subject(s) - rationality , irrational number , earnings , econometrics , economics , rational expectations , forecast error , function (biology) , variation (astronomy) , actuarial science , financial economics , finance , mathematics , physics , geometry , evolutionary biology , political science , astrophysics , law , biology
This paper proposes and tests a quadratic‐loos utility function for modeling corporate earnings forecasting, where financial analysts trade off bias to improve management access and forecast accuracy. Optimal forecasts with minimum expected error are optimistically biased and exhibit predictable cross‐sectional variation related to analyst and company characteristics. Empirical evidence from individual analyst forecasts is consistent with the model's predictions. These results suggest that positive and predictable bias may be a rational property of optimal earnings forecasts. Prior studies using classical notions of unbiasedness may have prematurely dismissed analysts' forecasts as being irrational or inaccurate.