The Neuroscience Behind the Stock Market's Reaction to Corporate Earnings News

Abstract:     
Using functional magnetic resonance imaging, we capture neural activity in the ventral striatum — a key area in the human brain’s reward processing circuit — of 35 adult investors learning the earnings per share disclosed by 60 publicly traded companies. Before imaging, investors forecasted each company’s earnings and took either a long or a short position in its stock. We find that striatal activation in investors’ brains explains just as much or more of the variation in risk-adjusted stock returns and abnormal share trading around earnings announcements than the dollar or percentage magnitude of the earnings surprise itself. We also find that, in aggregating investors’ individual reactions, the market seems to weigh more heavily the reactions of investors with greater brain activation, even after controlling for their financial expertise, forecasting ability, investment positions, and overall sensitivity to rewards and punishment.

Number of Pages in PDF File: 36

Keywords: financial accounting, earnings surprise, market reaction, human brain, neuroeconomics, neuroaccounting, fMRI

JEL Classification: M4, G1

working papers series