Post-Earnings Announcement Drift, Momentum, and Contrarian Strategies in the Saudi Stock Market: Risk Explanation vs. Behavioral Explanation

We studied the strategies exploiting the post-earnings announcement drift, the momentum, and the long-term return reversal in the Saudi stock market and their explanations. Using individual data for all the listed firms over the period 2010–2019, we found that these strategies are significantly profitable regardless of the formation and holding period length, and their profitability generally persists for the subperiods. Two controversial explanations for this profitability were examined using a time series approach: the risk-based rational explanation and the under- and overreaction-based behavioral explanation. We found that the profitability of the three strategies persists after controlling for risk using the Capital Asset Pricing Model, the Fama–French three-factor model, and the Fama–French five-factor model, which rejects the risk hypothesis. To examine the behavioral explanation, we extended the Fama–French five-factor model to include a factor reflecting the underreaction or the overreaction to quarterly earnings announcement based on unexpected earnings. Our findings indicate that the momentum can be explained by the market underreaction to firms’ earnings announcement, while the long-term return reversal cannot be explained by the overreaction to a series of similar information conveyed by earnings announcement events.