By Monica Sather | Student reporter
Investors should be careful about how to use and interpret financial analysts’ forecasts, suggests research by Hae mi (Amy) Choi, PhD, assistant professor.
Here, Choi discusses her research on macroeconomics and market uncertainty and why it is important to the business and Quinlan communities.
One major area that I study is macroeconomic conditions, specifically market uncertainty, and how that impacts investors and financial analysts. I believe that they are the most important participants in financial markets, and specifically the stock market.
One of my recent papers titled "Analysts’ Optimism and Incentives under Market Uncertainty" was published as a lead article in the Financial Review. In the paper, I examine how the financial analysts’ incentives and their forecasting performances are affected by this macroeconomic condition of market uncertainty. Market uncertainty is when investors have difficulty assessing the current and future market conditions because there is a lot of volatility within the market.
This specific paper looks at whether analysts’ incentives to be more opportunistic increases if there is a lot of volatility in the stock market. For instance, I found that financial analysts tend to issue more favorable and optimistic earnings forecasts for firms because they are penalized less for being inaccurate. They can attribute their inaccuracy to the volatile market conditions—it is not their fault; it is the market that’s uncertain.
On the other hand, the analysts are rewarded for this opportunistic behavior of optimism. Optimistic forecasts generate more trading activity, and if there is more trading, more trading commissions go to the brokerage firm that the analyst works for. So their incentives to issue optimistic forecasts are significant. What we found is that financial analysts who should be unbiased and should be working in the favor of the investors are not actually unbiased. They exhibit this opportunistic behavior that varies across different market conditions, and one market condition is market uncertainty. So investors should be careful about how to use and interpret these analysts’ forecasts, especially during these recent times of high market volatility.
Financial analysts are some of the most important information intermediaries in stock markets. Their earnings forecasts and stock recommendations have a great impact on stock investors, and hence, stock prices. Therefore, understanding analysts’ underlying incentives is necessary for interpreting and utilizing analysts’ forecasts and recommendations. My study is the first to look at how analysts’ incentives change with macroeconomic conditions—i.e., market uncertainty—over time.
In my studies, I view whether we are in a recession or an expansion as the average—the mean values of the economy or the market—whereas market volatility or market uncertainty are the variants.
So regardless of the mean, if there is a high variation in market conditions, how the variants impact participants in financial markets is an important question that has not been examined previously compared to the averages, like recessions versus expansions.
Everyone is interested in whether the economy will enter a recession, if the market level is low, and if the S&P 500 Index is lower or higher than last year. So I think this makes a contribution by looking at the variants in addition to the averages, and we find that these variants have an important effect on both investors and analysts.
If you want to be a good investor, you need to not only understand what’s going on within a firm, but also the macroeconomic conditions and the stock market conditions in general.
Once a student graduates and gets a job with their first full-time salary, a part of their salary will go towards their retirement account. The majority of this account is invested in the stock market. So regardless of your major, everyone working will be a future investor at some point.
Understanding how other investors in the stock market process information and how financial markets function is fundamental, as it impacts the wealth of us all.