Post-earnings announcement drift and parameter uncertainty: evidence from industry and market news

Claire Y. C. Liang () and Rengong Zhang ()
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Claire Y. C. Liang: University of Maine
Rengong Zhang: City University of Hong Kong

Review of Quantitative Finance and Accounting, 2020, vol. 55, issue 2, No 10, 695-738

Abstract: Abstract Post-earnings announcement drift (PEAD), one of the most prominent and robust return anomalies, is often attributed to investor naiveté or irrationality. A competing explanation is parameter uncertainty, which posits that PEAD may occur as rational investors encounter parameter uncertainty and must learn about the true values of a firm’s pricing parameters over time. This study extends the parameter uncertainty explanation for PEAD and hypothesizes that industry or market news arriving during the drift period affects drift strength. Consistent with our hypothesis, we find that the prices of high surprise firms show stronger responses to industry/market news in the drift period. Hence, the drift becomes stronger (weaker or reversed) when drift-period industry/market news agrees (disagrees) with a firm’s prior earnings news. The evidence helps to distinguish the parameter uncertainty theory from competing behavioral explanations based on investor naiveté or irrational biases, a task previous studies find difficult. Overall, our findings indicate that asset pricing anomalies need not imply investor irrationality—anomalies could arise from rational investors learning about pricing parameters over time.

Keywords: Post-earnings announcement drift; Earnings momentum; Anomaly; Parameter uncertainty; Rational learning (search for similar items in EconPapers)
JEL-codes: D83 G14 M41 (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (2)

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DOI: 10.1007/s11156-019-00857-w

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