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An analytical measure of market underreaction to earnings news

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  • Chung, Kee H.
  • Kim, Oliver
  • Lim, Steve C.
  • Yang, Sean

Abstract

Prior studies have provided a number of possible explanations for delayed market reactions to earnings announcements. However, there has been relatively little effort to predict the magnitude of the post-earnings announcement drift (PEAD). We show that the squared correlation coefficient (ρ2) between order imbalance and earnings surprise determines the magnitude of market underreaction to earnings surprises and PEAD=k⋅ρ2, where k is the information content of earnings. We discuss several testable implications of our analytical results, including a model-implied measure of information asymmetry that arises from the differential information processing ability of traders.

Suggested Citation

  • Chung, Kee H. & Kim, Oliver & Lim, Steve C. & Yang, Sean, 2019. "An analytical measure of market underreaction to earnings news," International Review of Economics & Finance, Elsevier, vol. 64(C), pages 612-624.
    • Handle: RePEc:eee:reveco:v:64:y:2019:i:c:p:612-624
    DOI: 10.1016/j.iref.2019.08.005
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    More about this item

    Keywords

    Strategic trading; Information asymmetry; Information precision; Liquidity demander; Liquidity provider; Order imbalance; Information content; Price impact;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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