You are here

Uncovering expected returns: Information in analyst coverage proxies

Uncovering expected returns: Information in analyst coverage proxies

By Charles M. C. Lee, Eric C. So
January 2016Working Paper No. 3367

This paper examines expected return information obtained by studying how security analysts allocate their limited attention and resources. Specifically, we decompose analyst coverage into abnormal and expected components using a simple characteristic based model and show that firms with abnormally high coverage subsequently outperform firms with abnormally low coverage by approximately 80 basis points per month.  Abnormal coverage rises following exogenous shocks to underpricing and predicts improvements in firms’ fundamental performance, suggesting that analysts provide more abnormal coverage for underpriced stocks. Our findings highlight both the usefulness of analyst actions in expected return estimations, and a potential inference problem when analyst coverage proxies are used to study information asymmetry and dissemination.