Analysts' Forecast Dispersion, Analysts' Forecast Bias and the Cross-Sectional Stock Returns

This paper examines the relation between divergence of opinion and stock returns. I find that analyst forecast dispersion, a popular proxy for divergence of opinion, is highly correlated with forecast bias. A decomposition of forecast dispersion into bias and disagreement reveals a strong positive relation between the disagreement component and returns. Further analysis shows that the high-dispersion-low-returns relation documented in Diether et al (2002) is driven by bias which is negatively associated with returns. The results show that investors require higher returns for holding high disagreement stocks, consistent with Merton (1987)'s view that divergence of opinion proxies for risk.