Analysts' earnings forecasts are not perfectly correlated with actual earnings. One statistical consequence is that the most optimistic and most pessimistic forecasts are usually too optimistic and too pessimistic. The forecasts' accuracy can be improved by shrinking them toward the mean. Insufficient appreciation of this statistical principle may partly explain the success of contrarian investment strategies, in particular why stocks with the most optimistic earnings forecasts under perform those with the most pessimistic forecasts.
This grant has produced a paper titled "Shrunken Earnings Predictions are Better Predictions, " coauthored by Margaret Hwang Smith, Manfred Keil, and Gary Smith. This paper has been published in Applied Financial Economics, 14, 2004, 937-943.
