OVERREACTION AND UNDERREACTION IN ANALYSTS FORECASTS

We examine hypotheses derived from behavioral decision theory regardin g conditions that lead to overreaction and conditions that lead to und erreaction in analysts' earnings forecasts. We argue that three heuris tics jointly influence earnings forecasts: leniency, representativenes s and anchoring and adjustment. We present a model for the concurrent influence of these heuristics on forecast errors, and examine three pr edictions of this model: (1) that there is a tendency towards overreac tion in forecast changes and underreaction in forecast revisions, (2) that there is overreaction to positive forecast modifications and unde rreaction to negative forecast modifications, and (3) that these biase s increase with the forecast horizon. (C) 1998 Elsevier Science B.V. A ll rights reserved.