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Analyst recommendations, mutual fund herding, and overreaction in stock prices
Nerissa C. Brown, University of Southern California
Kelsey D. Wei, University of Texas - Dallas
Russ Wermers, University of Maryland - College Park
ABSTRACT. This paper documents the tendency of mutual funds to follow analyst recommendation revisions when they trade, and the impact of analyst-motivated mutual fund “herds” on stock prices. After controlling for common signals that affect both analyst revisions and fund trading, we find that mutual fund herds follow consensus recommendation revisions. Consensus upgrades result in herds of funds buying a stock, while consensus downgrades result in herds selling. We find evidence that mutual fund herding impacts stock prices to a larger degree during our sample period than during prior periods. Further, we find evidence suggesting that mutual funds overreact when they herd—stocks heavily bought by herds tend to underperform during the following year, while stocks heavily sold outperform. These reversal patterns are even stronger when mutual fund herds follow analyst revisions. Overall, we find that the interaction between analysts and mutual funds plays an important role in setting prices.
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