Do Analyst Recommendations Yield Profitable Trading Strategies?: Evaluation of Analysts Covering European Stocks
Abstract: In addition to evaluating the performance of security analysts covering stocks traded on the European bourses we investigate the existence of any profitable trading strategies based on the same analysts’ recommendations. The performance is analyzed by forming portfolios (rebalanced weekly) based on the consensus recommendations for each covered company during the period January 1st 2001 to December 31st 2005. The returns earned from each portfolio are further evaluated against both market returns and a constructed benchmark consisting of value weightings of the stocks within the sample. In order to measure the impact of trading, and hence the cost of following the advice given by analysts, we also record each portfolio’s annual turnover. The recommendations of analysts are evaluated for robustness over time and across different market conditions. Efforts are made to prosper from the recommendations as an investor by constructing trading strategies. Additionally attempts to mitigate transaction costs are made in order to improve the net returns from the trading strategies. Our obtained results suggest that stock recommendations issued on European companies generate investment value but the costs inflicted by following the recommendations diminish the net returns. Using derivatives mitigates the costs inflicted by the high turnover which the strategies generate but fail to yield positive net returns.
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