Underreaction to Announced Earnings: Measurement and Empirical Proxies

• In Event: Financial Accounting & Reporting # 1
  In Paper Session: Financial Accounting and Reporting # 1

Abstract

In this study, we develop an operational definition of underreaction to announced earnings and investigate its empirical proxies. If a subset of traders does not fully react to earnings news, price does not instantly impound the news and good (bad) news generates a net buy (sell). We formalize this idea in a Kyle model and propose the correlation of order imbalance and earnings surprise (COE) as a new measure of underreaction. Empirically, COE, firm size, analyst following, and institutional holdings all explain the post-earnings announcement drift. When all four proxies compete, only COE and institutional holdings remain significant, which is consistent with the prediction of our model.

Authors

• Steve C Lim, Texas Christian University

• Oliver Kim, University of Maryland, College Park

• Kee H Chung, University at Buffalo, SUNY

• Sean Yang, University at Buffalo, SUNY