Investor Sophistication and Market Earnings Expectations

This paper investigates whether sophisticated investors rely more on analyst forecasts than on time-series model forecasts in forming expected earnings. Although analyst forecasts are generally more accurate than time-series model forecasts (e.g., O'Brien 1988), analyst forecasts are not clearly superior to time-series model forecasts as a proxy for expected earnings (e.g., Brown et al. 1987b). Recent research has concluded that earnings expectations reflected in stock prices at least partially reflect a seasonal random walk (SRW) model (Bernard and Thomas 1990 and Abarbanell and Bernard 1992). In particular, Ball and Bartov 1996 find that market earnings expectations incorporate the sign of the serial correlation in seasonally differenced earnings but underestimate the correlation magnitude (see also Maines and Hand 1996). These findings suggest that at least some market participants ignore public information in forming expected earnings; I examine whether information usage is correlated with investor sophistication and/or the degree to which investors are informed.