Changes in Analysts' Recommendations and Abnormal Returns

In this paper, we evaluate whether one can achieve higher abnormal return by following analysts' recommendations. We form monthly portfolios that invest (long) in stocks with the largest upgrade in consensus (average) recommendation and short stocks that have the largest downgrade in consensus recommendation. Once the self-financing portfolio is created, we hold the portfolio during the following month and measure its abnormal return based on the CAPM and four factor model. We find that these portfolios are associated with positive and significant alphas. We also find that these portfolios' alphas are highest when the portfolios are associated with small number of stocks rather with a large number of stocks. These results suggest that consensus recommendation changes may be useful for achieving higher returns. Further, tests show that recommendation changes are more valuable in the period from 1996 to 2003 than during the period from 2004 to 2011.