There is still a lot of controversy on the forecasting ability of analysts. On one hand, if markets are efficient in its semi-strong (or even strong) form, in the sense of Fama (1970), there would be no ground for the existence of research departments as it would be impossible to implement a profitable strategy on the basis of the publicly available information. Yet, some authors claim that evidence of analysts' forecasting ability in itself should not be interpreted as a violation of market efficiency if one cannot implement that strategy effectively. In other words, finding that research analysts play an important role in disseminating information may be consistent with market efficiency; only evidence of effective trading strategies on the basis of public information, such as research reports or analysts' recommendations, should be accepted as contradictory evidence. Recent research (see Wermers, 2000, as an example) suggests that the performance of active management is not superior to a passive strategy due to trading costs. Our research can thus also inform on the value created in active management done on the basis of stock picking skills.
On the other hand, in the last few years, there is growing suspicion on the information value of analysts' recommendations (particularly for sell side-analysts) motivated by anecdotal evidence on lack of independence of research departments due to pressures by other investment bank departments such as brokerage or M&A (Mergers & Acquisitions).
The main purpose of this study is to evaluate the effectiveness of several trading strategies built on the basis of the recommendations produced by a team of research analysts in a Portuguese investment bank. Analysts identify undervalued assets for which they issue a buy recommendation. These investment recommendations are regularly published.
All recommendations refer to stocks traded in markets for which the investment bank offers brokerage services.... [continues]
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