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Earnings response elasticity and post-earnings-announcement drift

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  • Zhipeng Yan

    (City College of New York)

  • Yan Zhao

    (City College of New York)

  • Wei Xu
  • Lee-Young Cheng

Abstract

This article studies the relationship between initial market response to earnings surprise and subsequent stock price movement. We first develop a new measure – the earnings response elasticity (ERE) – to capture initial market response. It is defined as the absolute value of earnings announcement abnormal returns (EAARs) divided by the earnings surprise. The ERE is then examined under various categories contingent on the signs of earnings surprises (+/−/0) and EAARs (+/−). We find that a weaker initial market reaction to earnings surprises, or lower ERE, leads to a larger post-announcement drift. A trading strategy of taking a long position in stocks in the lowest ERE quintile when both earnings surprises and EAARs are positive and a short position when both are negative can generate an average abnormal return of 5.11 per cent per quarter.

Suggested Citation

  • Zhipeng Yan & Yan Zhao & Wei Xu & Lee-Young Cheng, 2012. "Earnings response elasticity and post-earnings-announcement drift," Journal of Asset Management, Palgrave Macmillan, vol. 13(4), pages 287-305, August.
    • Handle: RePEc:pal:assmgt:v:13:y:2012:i:4:d:10.1057_jam.2012.8
    DOI: 10.1057/jam.2012.8
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    References listed on IDEAS

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