The efficiency of the italian stock exchange: Market reaction following changes in recommendations

Abstract

The main objective of this paper is to examine the market reaction to the recommendation changes issued by financial analysts. We study the peculiar case of Italy where analysts have to send their reports to the Stock Exchange Commission and the Stock Exchange the same day they give it to their clients. Reports are available on the Stock Exchange website. Our dataset includes about 5,200 reports issued on the 117 IPO firms that went public on the Italian Stock market between 1st January 1998 and 31st December 2003. We calculate abnormal returns and abnormal volumes associated with the dissemination of the reports and perform two short-term event studies: the first associated with the "report date", i.e. the date in which the analyst gives the report to private clients; the second one with regard to the "public access date", i.e. when the report is freely and publicly available on the Stock Exchange website. At the report date we find average abnormal returns of 1.01% for upgrades, and of - 0.92% for downgrades, both statistically significant. We also find abnormal returns the day before the report date. This can be the effect of other news affecting prices, or the violation of Italian regulation. The impact of recommendations changes is also analyzed in a three days event window [-1; +1], a pre-event [-15; -2] and a post-event window [+2; +15]. While at the report date the average abnormal return is slightly larger for upgrades, in the three event window downgrades have an higher impact (CAR= -2.06%) than upgrades (CAR= 1.89%), coherent with the previous literature. While there is no effect in the pre-event window, we find in the post-event window a CAR of 1.16% for upgrades and of - 1.29% for downgrades, both statistically significant, even if daily average abnormal returns are not statistically significant. We find abnormal volumes both in the three-days event window and some days before the report date, both for upgrades and downgrades. The event study related to the public access date show very different results. We do not find statistically significant average abnormal returns around this date, indicating that the market efficiently does not react to the mere publication of the report on the Stock Exchange website, since prices already included the effect of the recommendation change at the report date, i.e. when the new information was given to analyst's private clients. It remains to be investigated if the abnormal returns before the report date are due to the effect of news different from the recommendation change or if they show a violation of the Italian regulation.