Does The Stock Price Always Drift Toward Expected Earnings?

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

Abstract

A number of studies examine the price discovery process with respect to information about future earnings. In this paper, we examine a new dimension—the effect of seasonality—on the relation between expected earnings (EE) and subsequent price drift. We find that the relation between EE proxied by analyst forecasts and future returns is positive in non-January months but negative in January. The reverse January relation is observed among different types of stocks, domestic and international markets, and cannot be explained away by other variables associated with January returns. Further analysis suggests that the reverse January relation is a result of a temporary price drift away from fundamental value. In other words, we find that abnormal positive (negative) price drift does not always indicate under (over) valuation. Overall, our results illustrate the importance of controlling for the calendar-time dimension when studying market efficiency with respect to expected earnings.

Authors

• Peng-Chia Chiu, University of California, Irvine

• Alexander Nekrasov, University of California, Irvine