Do Financial Analysts Suffer from Inflation Illusion?

Do Financial Analysts Suffer from Inflation Illusion?
Author(s): Basu, Sudipta and Markov, Stanimir and Shivakumar, Lakshmanan
Year: 2005
Paper Number: GBS-ACC-2005-014
Goizueta Department: Accounting

Abstract

We examine whether financial analysts rationally incorporate expected inflation in their earnings forecasts for individual stocks. We find that expected inflation proxies such as lagged inflation and forecasts from the Michigan Survey of Consumers predict future earnings growth of a portfolio long in high-SUE firms and short in low-SUE firms, but analysts do not fully adjust for this relation. Analysts' earnings forecast errors can be predicted using these expected inflation proxies. We conclude that analysts' earnings forecasts are not fully efficient with respect to earnings information in inflation, and that this evidence is consistent with analysts' suffering from inflation illusion.