The Role of Investor Sentiment and Valuation Uncertainty in the Changes around Analyst Recommendations: Evidence from U.S. Firms

Abstract The authors investigate the empirical relation among investor sentiment, valuation uncertainty, and announcements of changes in analyst recommendation decisions among U.S. firms. Recent behavioral finance evidence shows market sentiment to have predictive content that affects the classical relationship between analyst recommendations and stock return dynamics. Contrary to this evidence, the authors find that degree of valuation uncertainty is associated to the impact of investor sentiment when examining a likelihood of consensus recommendation upgrade or downgrade. While not totally eliminating the significant investor sentiment effect under high valuation uncertainty, the investor sentiment does not powerfully explain the stock market reactions to analyst recommendation changes under low valuation uncertainty. Furthermore, the authors show that analyst recommendations provide significant buy or sell signals if valuation uncertainty is great, referring to the market being highly competitive. However, in less competitive markets, analyst reports become less informative. Overall, the authors demonstrate that magnitude of valuation uncertainty is an important complement to investor sentiment for further understanding analyst recommendations.