Evidence suggests behavioral biases creep into the expectations of even the most sophisticated investors — in this case Wall Street analysts. Their influence on stock prices offers a potential source of alpha; if investors can predict how behavioral biases will shape a Wall Street analyst's estimates, investors might capture excess returns as the market responds to analyst expectations.
Wall Street analysts' susceptibility to behavioral biases is significant because of their influence on stock prices. Research indicates their opinions — transparent in the form of publicly available earnings estimates — are one of the single greatest company-specific determinants of stock price movement.
We've measured the average stock price reaction to an analyst's earnings estimate revision for every revision since 2003: A single revision has an average 35-basis-point impact on a stock's price.
The influence Wall Street analysts have on stock prices commands greater appreciation when compared with actual earnings results, another frequent driver of stock returns. Figure 1 compares the average stock performance of companies that reported the top decile of earnings surprises in the last 20 years to the stock performance of companies that experienced the top decile of security analyst earnings revisions over the same period.
Not surprisingly, the stock price moves when a company reports better-than-expected earnings results; but that performance pales in comparison to the reaction when stocks receive numerous earnings revisions from Wall Street analysts.