Analysts’ Over-Optimistic Bias – From the Asymmetric Market Reaction to the Recommendations

The paper documents evidence regarding the asymmetric short-term market reactions to analysts' recommendations, in which the favorable recommendations consistently underperform the corresponding unfavorable recommendations across ratings and revisions. This market reaction asymmetry is attributed to two aspects of analysts' over-optimistic bias, the conscious distortion due to the conflicts-of-interest and the unconscious over-optimism due to the cognitive and behavioral bias. This paper analyzes the dynamics of the market reaction asymmetry and the result indicates a “self-correction” mechanism of the financial market which automatically reduces analysts' unconscious over-optimism. Failure to account for this “self-correction” mechanism leads to an overestimation of the regulatory effort by NASD Rule 2711 and NYSE Rule 472 in addressing the conscious distortion due to the issue of conflicts-of-interest