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Earnings announcement return extrapolation

Author

Listed:
  • Aytekin Ertan

    (London Business School)

  • Stephen A. Karolyi

    (Carnegie Mellon University)

  • Peter W. Kelly

    (University of Notre Dame)

  • Robert Stoumbos

    (Columbia University)

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.

Suggested Citation

  • Aytekin Ertan & Stephen A. Karolyi & Peter W. Kelly & Robert Stoumbos, 2022. "Earnings announcement return extrapolation," Review of Accounting Studies, Springer, vol. 27(1), pages 185-230, March.
    • Handle: RePEc:spr:reaccs:v:27:y:2022:i:1:d:10.1007_s11142-021-09593-w
    DOI: 10.1007/s11142-021-09593-w
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    References listed on IDEAS

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    More about this item

    Keywords

    Return extrapolation; Earnings announcements; Expectation formation;
    All these keywords.

    JEL classification:

    • G4 - Financial Economics - - Behavioral Finance
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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