Analysts dispersion forecast - Essay Example

Analysts Dispersion Forecast By Analysts Dispersion Forecast The AFD Capital executive managers consisting of Felix Phung, Kayvan Navabi, Precia Darshan, Raymond Tran, and Angela Shi, are the people who have prepared this report; the report is aimed for the use of the prospective clients and the fund’s existing clients. As part of our unique market research, our management has identified lucrative opportunity, and would thus like to propose a new trading strategy to facilitate the fund’s return.

The basis of our recommendation is the evidence of a negative correlation between security returns and the Analysts Forecast Dispersion. Analyst forecasts refer to public reports or announcements made by analysts on security valuation. The forecasts emphasise the strengths and concerns from their analysis of the information of the Company and are commonly used by the investors as indications of the direction and target price of an underlying security. Consequently, they have a real material impact on the movement of the security.

So as to evaluate the impacts of these forecasts on an aggregate basis, our management team has focused their research in Analyst Forecast Dispersion. In order to measure investor sentiment of an underlying security, Analyst Forecast Dispersion measures the difference in analyst opinions. A large measure or an increase in dispersion is an indication that there is greater aggregate uncertainty in analyst views in regard to the direction and the target price of an underlying security, and vice-versa.

The security is expected to generate lower returns due to the less certainty in regard to the intrinsic value; this in effect indicates a negative correlation between future returns and the Analytical Forecast Dispersion. At the beginning, this report examines the historical data for security returns and the Analyst Forecast Dispersion between the period 1983- 2005. Having examined the historical data, we will then identify the importance of the relationship between the two variables so as to drive an appropriate trading strategy.

Based on our analysis, there is sufficient empirical evidence confirming our hypothesis that there is a significant negative relationship between the two variables for the hedged portfolios and the Fama-MacBeth analysis for the smaller cap firms. For that reason, therefore, out team would wish to propose a short term momentum strategy through a short position in securities that have high dispersion and a long dispersion in securities with low dispersion. The approach will focus on small-to-medium cap-sized firms on a one month and one year basis.

Through the application of this strategy, our analysis predicts a sustainable annual return of up to 14.9% using the one moth hedge and transaction cost being covered by the one year hedge; the risk will be minimized through a net zero position. For this reason, therefore, we highly recommend this move as an appropriate inclusion in the fund’s hedging strategy. With this opportunity, we, therefore, welcome both the existing and the prospective clients to invest with AFD Capital through this strategy of low risks and lucrative returns.