Disagreement, Underreaction, and Stock Returns

We explore the analyst earnings forecasts data to study the interactive effect between disagreement and underreact to earnings news on asset prices. We find that (1) changes in the mean of forecasted earnings as an underreaction measure positively predict future returns, that (2) changes in the standard deviation of forecasted earnings as a disagreement measure negatively predict future returns, 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 crosssectional return setting and in the event-study setting around earnings announcements. Our evidence suggests that the analyst dispersion measure in Diether, Malloy, and Scherbina (2002) is mainly an underreaction measure instead of a disagreement measure. JEL Classification: G02, G12, G14