Disagreement, underreaction, and stock returns

Abstract

We explore analysts' earnings forecast data to improve on one popular disagreement measure-the analyst forecast dispersion measure-proposed by Diether et al. [Diether KB, Malloy CJ, Scherbina A (2002) Differences of opinion and the cross section of stock returns. J. Finance 57: 2113-2141]. Our analysis suggests that changes in the standard deviations of forecasted earnings can work as a complementary disagreement measure that is comparable across stocks and immune from other return-predictive information contained in the normalization scalars of analyst forecast dispersion measures. We also document evidence that the change-based disagreement measure predicts future cross-sectional returns significantly only when changes in the mean forecasts are negative. This finding suggests that the interaction between disagreement and underreaction to earnings news affects asset prices.