Earnings announcement return extrapolation

Aytekin Ertan (), Stephen A. Karolyi (), Peter W. Kelly () and Robert Stoumbos ()
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Aytekin Ertan: London Business School
Stephen A. Karolyi: Carnegie Mellon University
Peter W. Kelly: University of Notre Dame
Robert Stoumbos: Columbia University

Review of Accounting Studies, 2022, vol. 27, issue 1, No 6, 185-230

Abstract: Abstract We propose that extrapolative beliefs about earnings announcement (EA) returns may contribute to the understanding of EA return patterns. We construct a theoretically motivated measure of extrapolative investors’ expectations based on a stock’s recent history of EA returns. We then show that this measure explains cross-sectional variation in stock returns and investor behavior around EAs. Stocks expected to have high EA returns, according to our measure, experience predictable increases in prices before EAs and predictable decreases afterward. These patterns are economically significant: investors that buy (sell) a portfolio that is long firms with high recent EA returns and short firms with low recent EA returns in the pre-EA (post-EA) period earn daily five-factor abnormal returns of 16.1 bps (18.3 bps). Using individual investor trades data and a measure of institutional trading, we find that individual and institutional investors are more likely to purchase stocks with high recent EA returns, consistent with at least a subset of investors forming extrapolative beliefs about EA returns.

Keywords: Return extrapolation; Earnings announcements; Expectation formation (search for similar items in EconPapers)
JEL-codes: G12 G4 M41 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1007/s11142-021-09593-w

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