We examine hypotheses derived from behavioral decision theory regarding conditions that lead to overreaction and conditions that lead to underreaction in analysts' earnings forecasts. We argue that three heuristics jointly influence earnings forecasts: leniency, representativeness and anchoring and adjustment. We present a model for the concurrent influence of these heuristics on forecast errors, and examine three predictions of this model: (1) that there is a tendency towards overreaction in forecast changes and underreaction in forecast revisions, (2) that there is overreaction to positive forecast modifications and underreaction to negative forecast modifications, and (3) that these biases increase with the forecast horizon.
- Analysts' earnings forecasts
- Forecasts errors