Strategic Informed Trading and the Market Reaction to Earnings Announcements

We show that strategic informed trading that arises from information asymmetry (i.e., the difference in the precision of information) between the liquidity demander and the liquidity provider results in underreaction to earnings announcements. The price impact of a trade increases with the precision of the information used exclusively by the liquidity demander, but decreases with the precision of the information used by the liquidity demander and provider. The post-earnings announcement drift increases with both the price impact of a trade and the squared correlation coefficient between order imbalance and earnings surprise. We discuss several testable implications of our analytical results.

[1]  Charlie X. Cai,et al.  Market Reaction to Earnings News: A Unified Test of Information Risk and Transaction Costs , 2013 .

[2]  Srinivasan Sankaraguruswamy,et al.  Investor Sentiment and Stock Market Response to Earnings News , 2012 .

[3]  Karel Hrazdil,et al.  Market Efficiency and the Post-Earnings Announcement Drift , 2011 .

[4]  Brian W. Akins,et al.  Investor Competition Over Information and the Pricing of Information Asymmetry , 2011 .

[5]  David A. Hirshleifer,et al.  Limited Investor Attention and Stock Market Misreactions to Accounting Information , 2010 .

[6]  S. Titman,et al.  Individual Investor Trading and Return Patterns Around Earnings Announcements , 2010 .

[7]  M. E. Ellis.  What Drives the Disposition Effect? An Analysis of a Long-Standing Preference-Based Explanation , 2009 .

[8]  Stefano DellaVigna,et al.  Investor Inattention and Friday Earnings Announcements , 2009 .

[9]  Rodrigo S. Verdi,et al.  Implications of Transaction Costs for the Post-Earnings-Announcement Drift , 2007 .

[10]  Katherine Schipper,et al.  Information Uncertainty and Post-Earnings-Announcement-Drift , 2007 .

[11]  D. Hirshleifer,et al.  Driven to Distraction: Extraneous Events and Underreaction to Earnings News , 2007 .

[12]  Andrea Frazzini,et al.  The Disposition E ff ect and Underreaction to News , 2006 .

[13]  Ronnie Sadka,et al.  Momentum and Post-Earnings-Announcement Drift Anomalies: The Role of Liquidity Risk , 2006 .

[14]  Robert H. Battalio,et al.  Earnings expectations, investor trade size, and anomalous returns around earnings announcements , 2005 .

[15]  Tarun Chordia,et al.  Order imbalance and individual stock returns: theory and evidence , 2004 .

[16]  Clara Vega.  Stock Price Reaction to Public and Private Information , 2004 .

[17]  Frank Zhang,et al.  Information Uncertainty and Stock Returns , 2004 .

[18]  B. Ke,et al.  Do Institutional Investors Exploit the Post-Earnings Announcement Drift? , 2004 .

[19]  Jonathan S. Sokobin,et al.  Volume, Opinion Divergence and Returns: A Study of Post-Earnings Announcement Drift , 2003 .

[20]  D. Hirshleifer,et al.  Limited Attention, Information Disclosure, and Financial Reporting , 2003 .

[21]  Cristi A. Gleason,et al.  Analyst Forecast Revisions and Market Price Discovery , 2003 .

[22]  J. Ronen,et al.  On the Rationality of the Post-Announcement Drift , 2003 .

[23]  Richard R. Mendenhall.  Arbitrage Risk and Post-Earnings-Announcement Drift , 2002 .

[24]  Richard Roll,et al.  Orderimbalance, Liquidity and Market Returns , 2001 .

[25]  Nilabhra Bhattacharya.  Investors' Trade Size and Trading Responses around Earnings Announcements: An Empirical Investigation , 2001 .

[26]  Maureen O'Hara,et al.  The Accuracy of Trade Classification Rules: Evidence from NASDAQ , 2000 .

[27]  Hendrik Bessembinder,et al.  Issues in Assessing Trade Execution Costs , 2000 .

[28]  Suresh Radhakrishnan,et al.  Investor Sophistication and Patterns in Stock Returns after Earnings Announcements , 2000 .

[29]  T. Yohn.  Information Asymmetry around Earnings Announcements , 1998 .

[30]  Sudipta Basu.  The conservatism principle and the asymmetric timeliness of earnings , 1997 .

[31]  Teri Lombardi Yohn,et al.  Management Forecasts and Information Asymmetry: An Examination of Bid-Ask Spreads , 1997 .

[32]  Terrance Odean,et al.  Are Investors Reluctant to Realize Their Losses? , 1996 .

[33]  David Easley,et al.  Liquidity, Information, and Infrequently Traded Stocks , 1996 .

[34]  H. Stoll,et al.  Dealer versus auction markets: A paired comparison of execution costs on NASDAQ and the NYSE , 1996 .

[35]  Carla K. Hayn.  The information content of losses , 1995 .

[36]  A. Shleifer,et al.  The Limits of Arbitrage , 1995 .

[37]  M. Brennan,et al.  Investment analysis and price formation in securities markets , 1995 .

[38]  Ravi Bhushan,et al.  An informational efficiency perspective on the post-earnings announcement drift , 1994 .

[39]  Charles M. C. Lee,et al.  Spreads, Depths, and the Impact of Earnings Information: An Intraday Analysis , 1993 .

[40]  Charles M. C. Lee,et al.  Earnings news and small traders : An intraday analysis , 1992 .

[41]  V. Bernard,et al.  Evidence that stock prices do not fully reflect the implications of current earnings for future earnings , 1990 .

[42]  D. Shores.  THE ASSOCIATION BETWEEN INTERIM INFORMATION AND SECURITY RETURNS SURROUNDING EARNINGS ANNOUNCEMENTS , 1990 .

[43]  S. Kothari,et al.  An analysis of intertemporal and cross-sectional determinants of earnings response coefficients , 1989 .

[44]  A. Kyle.  Continuous Auctions and Insider Trading , 1985 .

[45]  G. Constantinides.  The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence: Discussion , 1985 .

[46]  Rowland K. Atiase,et al.  Predisclosure Information, Firm Capitalization, And Security Price Behavior Around Earnings Announcements , 1985 .

[47]  Sanford J. Grossman.  On the Impossibility of Informationally Efficient Markets , 1980 .

[48]  George Foster,et al.  Earnings Releases, Anomalies, and the Behavior of Security Returns , 2016 .

[49]  J. Tull.  Investor Trading and the Post-Earnings-Announcement Drift , 2010 .

[50]  Robert E. Verrecchia,et al.  Information Asymmetry around Earnings Announcements during the Financial Crisis , 2009 .

[51]  Robert E. Verrecchia,et al.  Market liquidity and volume around earnings announcements , 1994 .

[52]  Victor L. Bernard,et al.  POST-EARNINGS-ANNOUNCEMENT DRIFT - DELAYED PRICE RESPONSE OR RISK PREMIUM , 1989 .