Is It Prudent to Trade Around Analyst Recommendation Changes?

Abstract

In the wake of an increased emphasis on managing transactions costs, we investigate if the period surrounding analyst recommendation changes is appropriate for trading from the point of view of incurring lower transactional costs. We pick analyst recommendation changes because they are a highly frequent corporate event and it behooves a buy-side trader to know exactly how to react to such events. Using a sample of analyst recommendation changes made on all stocks trading in the NYSE and AMEX over an 18-month period, we find that public announcements of analyst recommendation changes are accompanied by a decrease in transaction costs over a period of 10 days surrounding the event. Our finding is surprisingly robust to the quality of the analyst, strength of the signal, size of the firm and level of institutional ownership in the firm. These results indicate that analyst recommendation changes (or news of impending recommendation changes) provide opportunities to institutional traders to execute large orders without increasing the costs of such executions.

TOPICS: Equity portfolio management, portfolio construction, exchanges/markets/clearinghouses