Can Analysts Assess Fundamental Risk and Valuation Uncertainty? An Empirical Analysis of Scenario-Based Value Estimates

We use a dataset of sell-side analysts' scenario-based equity valuation estimates to examine whether analysts are able to assess the risk surrounding a firm's fundamental value. We find that the spread in analysts' state-contingent valuations captures the riskiness of operations and predicts the absolute magnitude of future long-run valuation errors and changes in firm fundamentals (i.e., maps into the distribution of one-year-ahead price outcomes and changes in operating performance). Additionally, analysts' assessment of fundamental risk and predictive ability systematically shifted during and after the financial crisis, consistent with the macro-economic shock raising awareness among analysts of their firms' systematic risk exposures.