Sell-side analysts and stock mispricing: Evidence from mutual fund flow-driven trading pressure

Abstract

Using the setting of extreme mutual fund flow-driven trading pressure, this paper examines sell-side analysts’ role in stabilizing capital markets. We find that a select group of analysts persistently issue price-correcting recommendation changes for stocks experiencing mutual fund flow-driven mispricing. Such recommendation changes are accompanied by little change to their concurrent earnings forecasts and appear to be driven by the superior research skill of these “mispricing-sensitive” analysts. Stocks receiving price-correcting recommendation changes experience less severe liquidity deterioration, more immediate price correction, and consequently smaller subsequent long-run return reversal. Our findings highlight analysts’ unique role in facilitating liquidity provision and stabilizing capital markets during severe mispricing events.