A kinetic theory approach to consensus formation in financial markets

Abstract

It is sometimes acknowledged that (sell-side) equity analysts' recommendations influence investors and therefore market prices. In particular, the S&P 500 is expected to decline (respectively rise) when analysts revise their targets downward (respectively upward). Our findings indicate not only that analysts' consensus exert no influence on market prices, but also that, conversely, analysts appear to set their target prices based on markets prices. Employing a kinetic theory framework, we model the dynamics of analysts' opinions, by taking into account both the mutual influences shaping price consensus and the dynamics of the actual S&P 500 index level. The model is calibrated on a training subset of data and tested on an independent set to assess its predictive power. Our tests show that just three free parameters are enough to accurately predict the one-year average price forecasts of analysts.