Irrational analysts' expectations as a cause of excess volatility in stock prices

This paper investigates whether excess stock price volatility may be due in part to a failure of the market to form rational expectations. Using data on analysts' expectations of long run earnings growth for individual companies, we report a number of interrelated results which lend support to this hypothesis. These results together imply that the cross‐section of stock prices will also be excessively dispersed, so that stocks with low earnings expectations are underpriced and stocks with high earnings expectations are overpriced. As analysts' forecasts errors become apparent, stock prices adjust accordingly and so excess returns accrue.