The Short-Duration Premium and News Announcements

Abstract

To investigate the origins of the unconditional short-duration premium, we study its dynamics at pre-scheduled news announcements. For macroeconomic news, long-duration stocks earn higher returns than short-duration stocks. On the flip side, returns for short-duration stocks are significantly elevated on earnings announcement days. Focusing on earnings announcement as a laboratory for the pricing of firm-specific news, we differentiate between three competing explanations. We find strong support for the idea that investors are overly optimistic about long-term cash-flows, leading to an overvaluation of long-duration stocks. This overvaluation is in part corrected at earnings announcements, explaining the lower return response of long- compared to short-duration stocks. Finally, we can establish a direct link between an increase in cash-flow duration and a stock's overvaluation. We also present empirical evidence against the two competing explanations.

Keywords: equity term structure, cash-flow duration, mispricing, news announcements, analyst forecasts, limits to arbitrage

JEL Classification: G12, G14, G40