The Investment Value of Australian Security Analyst Recommendations: An Application of the Black-Litterman Asset Allocation Model

Abstract

The study empirically examines the investment value of analyst recommendations on constituent stocks of the S&P/ASX 50 index. For the period from 30 June 1997 to 30 October 2007, we find that stocks with favourable consensus recommendations (“strong buy” and “buy”) on average earn a higher return than the market, whereas stocks with unfavourable recommendations (“strong sell” and “sell”) earn a lower return. An investment strategy using the Black-Litterman asset allocation model that overweights (underweights) stocks with favourable (unfavourable) consensus recommendations, in conjunction with daily rebalancing, outperforms the market in terms of raw return and risk adjusted performance measures. The investment strategy involves high levels of trading and, as a result, no significant abnormal returns are achieved after accounting for transaction costs. Less frequent rebalancing, under most situations, causes a decrease in both performance and turnover. Filtering of dated recommendations causes an increase in turnover, whilst having mixed effects on investment returns.