Prospect theory, analyst forecast, and stock returns

• Main Authors: DING, David K., Charoenwong, Charlie, Seetoh, Raymond
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2004
• Subjects: Behavioral finance; prospect theory; analyst forecasts; earnings growth; earnings surprise; Business; Corporate Finance; Finance and Financial Management
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/1158; https://ink.library.smu.edu.sg/context/lkcsb_research/article/2157/viewcontent/SSRN_id566961__1_.pdf
• Institution: Singapore Management University

This paper documents how prospect theory can be used to explain stock returns and analysts' forecast behavior. Positive earnings surprises are associated with increases in abnormal returns but negative earnings surprises have only a limited negative impact on returns. We find that analysts display asymmetric behavior towards positive and negative earnings growth. Analysts' forecasts are found to be accurate during periods of positive earnings growth, but overly optimistic during periods of negative earnings growth. Our findings have implications for the structuring of investment products, as well as the role of market timing in their introduction.