The Best of All Possible Worlds: Unraveling Target Price Optimism Using Analysts’ Scenario-Based Valuations

Abstract

We document that the relative placement of analysts’ target price within their subjective distribution of scenario-based valuations for the covered firm (i.e., tilt) is informative to investors. When analysts forecast price appreciation, tilt incrementally predicts ex post valuation errors and realized returns; the predictive value of tilt disappears when analysts forecast price declines. In additional analyses, we find that tilt appears to reflect an optimistic bias in target price forecasts as opposed to information about asymmetric state-contingent risk payoffs. Finally, we document that investors can use estimates of implied tilt based on observable firm characteristics to distinguish between investments with equally optimistic target price forecasts, yet lacking scenario-based information.

Keywords: Financial Analysts, Scenario-based Valuations, Target Prices, Optimism, Bias

JEL Classification: G24, G11, G02