THE CORRELATION BETWEEN STOCK RETURNS BEFORE AND AFTER ANALYST RECOMMENDATION REVISIONS

Abstract

In this study I analyse the correlation between stock returns before and after analyst recommendation revi-sions. I hypothesise that if a recommenda-tion revision for a given stock takes place after a short period when the stock’s price moves in the opposite direction, it may in-dicate that the fundamentals that caused the analyst to revise their recommendation are less completely (if at all) incorporated in the stock price, significantly increasing the probability of subsequent post-event price drift. Analysing a large sample of rec-ommendation revisions, I document that both recommendation upgrades and down-grades are followed by significant one-to-six-month price drifts (reversals) if they are preceded by the opposite-sign (same-sign) short-term cumulative abnormal returns. The effect remains significant after ac-counting for additional relevant company-specific (size, Market Model beta, historical volatility) and event-specific (stock’s return and trading volume on the event day, bro-kerage firm size, analyst experience, rec-ommendation category before the revision, number of categories changed in the revi-sion) factors.