A simple explanation for the dispersion anomaly∗

We explain the dispersion anomaly, the tendency of stocks with high analyst forecast dispersion to produce lower future returns, by testing the implied assumption that analysts’ bias is distributed equally when portfolios are sorted by dispersion (Johnson, 2004). We find that analysts’ bias is not symmetrically distributed across dispersion groups. High dispersion firms contain forecasts that are too optimistic, but the over optimism in low dispersion firms is much less. Given the well-known tendency of analysts to walk-down their forecasts over the fiscal year, this asymmetry produces future negative forecast revisions for the high dispersion firms. These negative cash flow shocks are sufficient to completely explain the dispersion anomaly. ∗Preliminary manuscript, please do not circulate without permission. Comments welcome. We thank Stan Markov for helpful comments. Send correspondence to [email protected] A simple explanation for the dispersion anomaly