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Explanations: Why Post-Earnings-Announcement Drift Occurs, Why Stock Prices Tend to Rise after a Stock Split, and Some Reasons Why Managements Smooth Earnings

73 Pages Posted: 2 Sep 2008  

Michael M. Grayson

CUNY Brooklyn College

Multiple version iconThere are 2 versions of this paper

Date Written: August 31, 2008

Abstract

This study addresses the issue of post-earnings-announcement drift. According to the present theory of how capital markets behave, the drift cannot occur if either the capital asset pricing model (CAPM) or the efficient market hypothesis (EMH) is valid. The drift is a drift away from the CAPM price, which means that CAPM cannot be how the market mechanically determines prices. The drift has been known since at least 1968, which means that an allegedly efficient market knows of the drift, yet does not take the drift into account in setting prices and thereby drive the drift out of existence. The existence of the drift means that the market cannot be completely efficient even within a time frame of three months.

This article uses economic modeling to determine the components of the drift, the results of a field study to explain why the drift occurs, and tests of hypotheses to confirm the results of the economic modeling and field study. This article also explains (1) why the size of the drift varies by size of the company, (2) that the market is not efficient, (3) why stock prices tend to rise after a stock split, and (4) some of the incentives for managements to smooth earnings.

Keywords: post-earnings-announcement drift, capital asset pricing model, efficient market hypothesis, market microstructure

JEL Classification: D40, G12, G14, G24, M41, M43

Suggested Citation

Grayson, Michael M., Explanations: Why Post-Earnings-Announcement Drift Occurs, Why Stock Prices Tend to Rise after a Stock Split, and Some Reasons Why Managements Smooth Earnings (August 31, 2008). Available at SSRN: https://ssrn.com/abstract=1261646 or http://dx.doi.org/10.2139/ssrn.1261646

Michael M. Grayson (Contact Author)

CUNY Brooklyn College ( email )

2900 Bedford Avenue
Brooklyn, NY 11210
United States

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