Analysts’ Reinitiations of Coverage and Market Underreaction


Speaker


Abstract

I study the informativeness of reinitiations of coverage, which are defined as the resumption of coverage of a stock by a broker after more than 6 months of interruption. Reinitiations are associated with a significant short-term market response, in particular when the same analyst is assigned to the stock. However, I show that this market response is incomplete. Interestingly, the price patterns that follow the issuance of regular upgrades of recommendation and reinitiations differ significantly. Prices adjust quickly after a regular upgrade, while reinitiations are followed by a sustained price increase in the following 6 months. I assess the economic magnitude of this initial underreaction by setting up a trading strategy. I show that reinitiations of coverage are the only type of recommendation that delivers significant positive abnormal returns after transaction costs with a 3 and 6 month investment horizon. I investigate several explanations in relation to gradual information diffusion, limited attention and changes in firm profitability. Portfolio sorts on proxies for market attention indicate that firms subject to a lower level of initial attention experience the strongest cumulative abnormal returns. Reinitiations also coincide with improvements in firms' profitability.