Individual Investor Over-Extrapolation

• In Event: Earnings News Anomalies

Abstract

We present evidence that individual investors over-extrapolate earnings announcement performance. Investors are overly optimistic about a firm’s future earnings if recent earnings surprises were high, and they are more likely to purchase the firm’s stock immediately before the upcoming earnings announcement if recent earnings announcement returns were high. This purchasing behavior is associated with predictable increases in prices before earnings announcements and predictable decreases afterwards, with the reversal providing evidence of over-extrapolation. Portfolios based on pre-earnings announcement price increases and post-earnings announcement reversals both earn over 17 basis points per day.

Authors

• Stephen Adam Karolyi, Carnegie Mellon University

• Aytekin Ertan, London Business School

• Peter Kelly, Notre Dame

• Robert Stoumbos, Yale University