Credit rating, Post-earnings-announcement-drift, and Arbitrage from transient institutions

• In Event: SESSION 5D: Earnings Announcements and Returns

Abstract

This study establishes a robust link between credit rating and post-earnings-announcement-drift (PEAD). I find strong evidence that PEAD is much stronger for firms with lower credit ratings. The credit rating effect on PEAD is unexplained by traditional information uncertainty proxies such as earnings volatility, cash flow volatility, accrual quality, firm age, idiosyncratic volatility, and analyst forecast dispersion. Further, I investigate whether transient institutions exploit the differential of PEAD among different rated firms in their arbitrage trades. My results reveal that transient institutions tend to focus their arbitrage on low credit rating firms which are featured as abundant in arbitrage profits and that ex ante transaction cost impedes the transient institutions from exploiting the PEAD in the low rated firms. This evidence is taken to be suggestive of underreaction story rather than arbitrage risk story to explain why PEAD anomaly concentrates in low credit rating firms.

Author

• Guanming He, University of Warwick, United Kingdom