Dispersion in analysts’ earnings forecasts and credit rating

Buying stocks with low dispersion in analysts earnings forecasts and selling stocks with high dispersion yields statistically significant and economically large payoffs (Diether, Malloy, and Scherbina (2002)). • This negative relation between dispersion and returns (dispersion effect) is an anomaly. • Investors pay a premium for bearing uncertainty. This anomaly is unexplained by the Fama and French (1993) three-factor model, and by the Fama-French model augmented by a momentum factor. Suggested causes for the dispersion effect: • difference of opinion among investors and market frictions that prevent the revelation of negative opinions (Diether, Malloy, and Scherbina (2002)), • unpriced information risk (Johnson (2004)) – dispersion proxies for idiosyncratic risk, which, in the presence of leverage, is negatively related with returns, • illiquidity (Sadka and Scherbina (2007)) explains the persistence of the dispersion effect