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Arbitrageurs and overreaction to earnings surprises

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  • Contreras, Harold
  • Marcet, Francisco

Abstract

This paper explores whether arbitrage trades could cause overreaction to earnings announcements. We contrast two hypotheses in a horse race: (1) whether short covering over positive news stocks generates overshooting in stock returns; (2) whether momentum traders trying to arbitrage the post-earnings announcements drift cause overreaction. We find evidence in line with the two hypotheses, but the overshooting is stronger for stocks with high covering. Also, we find that short sellers spot this overreaction and trade these stocks intensively. However, they trade more stocks with high short covering, suggesting that short sellers close their positions quickly to open new ones.

Suggested Citation

  • Contreras, Harold & Marcet, Francisco, 2021. "Arbitrageurs and overreaction to earnings surprises," Finance Research Letters, Elsevier, vol. 43(C).
    • Handle: RePEc:eee:finlet:v:43:y:2021:i:c:s1544612321000751
    DOI: 10.1016/j.frl.2021.101994
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    References listed on IDEAS

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    More about this item

    Keywords

    Arbitrage; Short covering; Momentum traders; Earnings announcements;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G40 - Financial Economics - - Behavioral Finance - - - General

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