Does Uncertainty Boost Overconfidence? The Case of Financial Analysts’ Forecasts

This article examines the link between uncertainty and analysts' reaction to earnings announcements for a sample of European firms during the period 1997-2007. In the same way as Daniel, Hirshleifer and Subrahmanyam (1998), we posit that overconfidence leads to an overreaction to private information followed by an underreaction when the information becomes public. Psychological findings suggest that this effect is more prominent in an uncertain environment. Our tests are based on the relationship between forecast revisions and forecast errors. When analysts excessively integrate information in their revisions (i.e. overreact), their forecast revisions are too intense, and the converse occurs when they underreact. As a proxy for uncertainty we analyze two subsamples: high-tech and low-tech firms. Our results support the overconfidence hypothesis. We jointly observe the two phenomena of under- and overreaction. Overreaction occurs before the public release and disappears after it. Our results also show that both effects are more significant for the high-tech subsample. For robustness, we sort the sample using analyst forecast dispersion as a proxy for uncertainty and obtain similar results. We also document the fact that the high-tech stock crash in 2000-2001 moderated analysts' overconfidence