We propose a theory of securities market under- and overreactions based on two well-known psychological biases: investor overconfidence about the precision of private information; and biased self-attribution, which causes asymmetric shifts in investors ’ confidence as a function of their investment outcomes. We show that overconfidence implies negative long-lag autocorrelations, excess volatility, and, when managerial actions are correlated with stock mispricing, public-event-based return predictability. Biased self-attribution adds positive short-lag autocorrela-tions ~“momentum”!, short-run earnings “drift, ” but negative correlation between future returns and long-term past stock market and accounting performance. The theory also offers several untested implications and implications for corporate fi-nancial policy. IN RECENT YEARS A BODY OF evidence on security returns has presented a sharp challenge to the traditional view that securities are rationally priced to re-f lect all publicly available information. Some of the more pervasive anoma-

We examine securityanalysts’career concerns byrelating their earnings forecasts to job separations. Relativelyaccurate forecasters are more likelyto experience favorable career outcomes like moving up to a high-status brokerage house. Controlling for accuracy, analysts who are optimistic relative to the consensus are more likelyto experience favorable job separations. For analysts who cover stocks underwritten by their houses, job separations depend less on accuracyand more on optimism. Job separations were less sensitive to accuracyand more sensitive to optimism during the recent stock market mania. Brokerage houses apparentlyreward optimistic analysts who promote stocks. MANY IN THE FINANCIAL PRESS call the decade of the 1990s the ‘‘Age of the Analysts’’ on Wall Street (see Nocera (1997), Cole (2001)). Once relegated to producing boring reports on stocks in the back rooms of brokerages, analysts are now an integral part of Wall Street profit centers. Through media outlets such as CNBC, analysts reach millions of individual investors. At the same time, investment bankers relyon analysts to help them land investment-banking deals. Analysts who are influential among institutional buyers such as mutual fund managers can generate heftytrading commissions for their brokerages. The growing prominence of these analysts in financial markets has led to heightened scrutinyof their career concerns.This scrutinyhas recentlyreached a peak as well-known e-commerce analysts such as Mary Meeker and Henry Blodget were criticized for maintaining buyratings on manydot-com stocks even as their once sky-high valuations collapsed. Congressional hearings are underwayto consider reforms to protect na| « ve individual investors who lost moneyas a result of these overoptimistic recommendations.These hearings to‘‘analyze the analysts,’ ’ as some in financial press are calling it, are looking into the career n

Carolina at Chapel Hill for helpful comments and suggestions and Jay Ritter and Michel Vetsuypens for We examine data on analyst following for a sample of initial public offerings completed over the 1975-1987 period to see how they relate to three well-documented IPO anomalies. We find that higher underpricing leads to increased analyst following. Analysts are overoptimistic about the earnings potential of recent IPOs and about their long term growth prospects. More firms complete IPOs when analysts are particularly optimistic about the growth prospects of recent IPOs. In the long run, IPOs have better stock price performance when analysts ascribe low growth potential to these firms than when they ascribe high growth potential. These results suggest that the anomalies documented in the IPO market may, at least partially, be driven by overoptimism. 1 1.

We review extensive evidence about how psychological biases affect investor behavior and prices. Systematic mispricing probably causes substantial resource misallocation. We argue that limited attention and overconfidence cause investor credulity about the strategic incentives of informed market participants. However, individuals as political participants remain subject to the biases and self-interest they exhibit in private settings. Indeed, correcting contemporaneous market pricing errors is probably not government’s relative advantage. Government and private planners should establish rules ex ante to improve choices and efficiency, including disclosure, reporting, advertising, and default-option-setting regulations. Especially

We investigate directly whether analyst behavior influenced the likelihood of banks winning underwriting mandates for a sample of 16,625 U.S. debt and equity offerings sold between December 1993 and June 2002. We control for the strength of the issuer’s investment-banking relationships with potential competitors for the mandate, prior lending relationships, and the endogeneity of analyst behavior and the bank’s decision to provide analyst coverage. We find no evidence that aggressive analyst recommendations or recommendation upgrades increased their bank’s probability of winning an underwriting mandate after controlling for analysts ’ career concerns and bank reputation. Our findings might be interpreted as suggesting that bank and analyst credibility are central to resolving information frictions associated with securities offerings.

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This paper develops generalized method-of-moments tests for the rationality of earnings per share forecasts made by individual stock analysts. We fail to reject the hypothesis of rationality as long as we take into account two complications: (1) the correlation in a given period of analysts ’ forecast errors in predicting earnings for firms in the same industry and (2) discretionary asset write-downs, which affect earnings but are intentionally ignored by analysts when they make earnings forecasts. Our results challenge earlier work by De Bondt and Thaler and by Abarbanell and Bernard that found irrationality in analysts ’ forecasts. I.

This study investigates security analysts ' reactions to public management guidance and assesses whether managers successfully guide analysts toward beatable earnings targets. We use a panel data set between 1995 and 2001 to examine the fiscal-quarter-specific determi-nants of management guidance and the timing, extent, and outcomes of analysts ' reactions to this guidance. We find that management guidance is more likely when analysts ' initial forecasts are optimistic, and, after controlling for the level of this optimism, when analysts' forecast dispersion is low. Analysts quickly react to management guidance and are more likely to issue final meetable or beatable earnings targets when management provides public guidance. Our evidence suggests that public management guidance plays an important role in leading analysts toward achievable earnings targets.

We attempt to measure the effect of competition on bias in the context of analyst earnings forecasts, which are known to be excessively optimistic due to conflicts of interest. Our natural experiment for competition is mergers of brokerage houses, which result in the firing of analysts because of redundancy (e.g., one of the two oil stock analysts is let go) and other reasons such as culture clash. We use this decrease in analyst coverage for stocks covered by both merging houses before the merger (the treatment sample) to measure the causal effect of competition on bias. We find the treatment sample simultaneously experiences a decrease in analyst coverage and an increase in optimism bias the year after the merger relative to a control group of stocks, consistent with competition reducing bias. The implied economic effect from our natural experiment is significantly larger than estimates from OLS regressions that do not correct for the endogeneity of coverage. And this effect is much more significant for stocks with little initial analyst coverage or competition.

This paper asks whether momentum and post-event drift are manifestations of the same underlying mechanism or whether they are separate phenomena. We find that both effects can be attributed to persistence in returns following news which affects expected earnings or earnings growth. Holding these quantities fixed, there is no momentum effect, nor is there post-event drift for our sample of events, which includes seasoned equity offerings, re-purchases, equity-financed mergers, and dividend initiations Two of the most convincingly documented stock market anomalies are momentum and post-event drift. Momentum refers to the persistent excess returns of winner portfolios over loser portfolios, where winners and losers are judged over a backwardlooking