Disagreement, underreaction, and stock returns

We explore the analyst earnings forecasts data to study the interactive effect between disagreement and underreaction to earnings news on asset prices. We find that (1) changes in the mean of forecasted earnings, as an underreaction measure, predict future returns positively and significantly; that (2) changes in the standard deviation of forecasted earnings, as a disagreement measure, predict future returns negatively and marginally; and more importantly, that (3) changes in the standard deviation predict future returns significantly only when changes in the mean are negative. Our results are robust both in the standard cross-sectional return setting and in the event-study setting around earnings announcements. Our evidence suggests that the return predictability of analyst forecast dispersion measure in Diether, Malloy, and Scherbina (2002) is mainly contributed by the underreaction component in the measure’s deflator rather by the disagreement component in the numerator