Evidence that Capital Markets Learn from Academic Research: Earnings Surprises and the Persistence of Post-Announcement Drift

We investigate the relation between earnings surprises and post-announcement stock returns for 1991-1997, and show that the profit opportunities previously associated with simple trading strategies designed to exploit the drift phenomenon have now been substantially eliminated. This profitability decline does not appear to be due to increased earnings "noise" from transitory items or to structural changes in the serial correlation of earnings surprises. The post-announcement drift persists where arbitrage costs are highest; that is, among small NYSE/AMEX firms, and among firms with little or no analyst following or with low stock prices. The evidence is consistent with the notion that investors used earnings surprise trading strategies to arbitrage the drift once the phenomenon had been well documented in academic research.

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