The Predictability of Analyst Coverage on Stock Returns - Empirical Evidence from China's Stock Market

Sammanfattning: This paper studies the association between the analyst coverage (both total analyst coverage and abnormal analyst coverage) and future stock returns in Shanghai A-share stock Market over a period of ten years from 2008 to 2017. Our study draws inspiration from the work of Charles M.C. Lee and Eric C. So (2016). We first get the abnormal analyst coverage by decomposing observed analyst coverage into expected and abnormal parts applying residual analyst coverage model. Then by applying portfolio sorts and Fama-Macbeth panel regression, we find that abnormal analyst coverage, which is unobserved in the market, is positively associated with future stock returns indicating that stocks that receive abnormally higher (lower) coverage from analysts are followed by higher (lower) returns. Based on this finding, we further prove that a monthly-rebalanced strategy that longs stocks in the highest quintile of abnormal analyst coverage and at the same time shorts stocks included in the lowest quintile could provide an annualized return of approximately 10% on average, robust to standard asset pricing factors (RMRF, SMB, HML, MOM). These findings have great significance on the study of the predictability of analyst coverage, especially in Chinese market, as well as on the guidance of investing in China's stock market.