Dispersion In Analysts' Earnings Forecasts And Credit Rating

This paper shows that the puzzling negative cross-sectional relation between dispersion in analysts' earnings forecasts and future stock returns results from financial distress as proxied by credit rating downgrades. In particular, the profitability of dispersion based trading strategies is concentrated in a small number of the worst-rated firms and is significant only during periods of deteriorating credit conditions. In such periods, the negative dispersion-return relation emerges as low-rated firms experience substantial price drop along with considerable increase in forecast dispersion.