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This paper proposes an index for evaluating the internalization
of an analyst's recommendations by investors at various
points of time that follow the recommendation day. The model
is applied to the Israeli stock market for the years 2004
and 2005. The results indicate that investors in the Israeli
stock market internalize a recommendation 14 days after
its publication. Internalization continues 30 days after
the publication day. The importance of this paper is that
it is the first time an index for evaluating investor's
reaction to analyst's recommendations in various stock markets
has been proposed. Such information is valuable, since it
can improve investment strategies that follow the publication
of an analyst's recommendation. An investor would prefer
buying a recommended stock when he expects a large return
and would sell it when the recommendation's effect is exhausted.
The analysts' forecasts have been the major basis of investment
decisions for both institutional and individual investors
because analysts possess more professional knowledge about
analysis and industry. Their professional knowledge includes
expert skill in data collection and analysis. Moreover,
they have a better understanding of a particular industry
or company. Prior research indicated that analysts' forecasts
were more accurate than the forecasts derived from statistical
or mathematical models (Brown et al., 1987; and Lobo, 1991).
In opposition to this, other research indicates that financial
analysts' forecasts of earnings are biased and fail to fully
incorporate earnings-relevant information (Mendenhall, 1991;
Ali et al., 1992; Francis and Philbrick, 1993; Elgers and
Lo, 1994; and Elliot et al., 1995). Consequently, researchers
often conclude that analysts' forecasts are suboptimal or
irrational.
Academic studies show that analysts' coverage has become
an integral component of equity evaluation and the investment
process (see Cragg and Malkiel, 1968; Givoly and Lakonishok,
1984; La Porta, 1996; and Brave and Lehavy, 2003). Further
research shows that analysts have an immediate effect on
stock prices.Jensen and Meckling (1976) and Womack (1996) claim that
analysts reduce the asymmetries between managers and outside
investors. Therefore, they surmise that increasing analysts'
coverage is more likely to be plagued by information and
engage in non-value maximizing corporate activities. Consequently,
analysts of covered firms are expected to trade below fundamental
values. A firm with a large analyst coverage should have
a greater amount of private information filtered to investors.
As a result, trading of such securities should be more informationally
efficient (Moyer et al., 1989).
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