On the relation between forecast precision and trading profitability of financial analysts

We analyze the relation between earnings forecast accuracy and the expected profitability of financial analysts. Modeling forecast errors with a multivariate normal distribution, a complete characterization of the payoff of each analyst is provided. In particular, closed-form expressions for the pro...

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Bibliographic Details
Published in:Journal of financial markets (Amsterdam, Netherlands) Netherlands), 2014-09, Vol.20, p.39-60
Main Authors: Marinelli, Carlo, Weissensteiner, Alex
Format: Article
Language:English
Subjects:
Financial analyst
Forecast accuracy
Full communication equilibrium
Recommendation profitability
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Summary:We analyze the relation between earnings forecast accuracy and the expected profitability of financial analysts. Modeling forecast errors with a multivariate normal distribution, a complete characterization of the payoff of each analyst is provided. In particular, closed-form expressions for the probability density function, for the expectation, and, more generally, for moments of all orders are obtained. Our analysis shows that the relationship between forecast precision and trading profitability needs not be monotonic, and that the impact of the correlation between the forecasts on the expected payoff of any single analyst depends on the relative accuracy of his signal. •The link between forecast precision and trading profitability might be non-monotonic.•In case of positively correlated forecasts this relationship is J-shaped.•The impact of correlation on the expected payoff depends on the forecast accuracy.•We provide the expected payoff, the density and all higher moments in closed form.
ISSN:1386-4181
1878-576X
DOI:10.1016/j.finmar.2014.03.001