Information Uncertainty and the Reaction of Stock Prices to News

69 Pages Posted: 29 Oct 2010

Multiple version iconThere are 3 versions of this paper

Date Written: July 30, 2010

Abstract

Recent theoretical papers suggest that high uncertainty about firms’ economic prospects can explain delays in the adjustment of their stock prices to economic news. Using analyst forecast revisions and earnings announcements as proxies of news, we find mixed evidence in support of this hypothesis. We confirm that stocks of firms whose prospects are highly uncertain display a relatively large delayed price reaction (so-called continuation) after the release of news, but we argue that this evidence does not necessarily imply a slower adjustment speed. Indeed, for these stocks the immediate reaction to news is also relatively strong. In fact, the magnitude of the delayed price reaction (the price continuation) depends both on the degree of price sluggishness and on the “scale” of the news hitting the stock. We therefore consider both the delayed and immediate responses, and compute measures of adjustment speed that do not depend on the “scale” of the news. We then compare these measures across portfolios of stocks characterized by different degrees of uncertainty. Our findings indicate that: (i) stock prices characterized by high uncertainty tend to adjust to bad news more sluggishly than those characterized by low uncertainty; (ii) the opposite holds true in the case of good news; (iii) stock prices characterized by high uncertainty tend to adjust to bad news more sluggishly than to good news. Previous empirical literature focuses on price continuation patterns but neglects to control for the “scale” of the news, reaching erroneous conclusions.

Keywords: stock price continuation, price adjustment speed, news, earnings announcements, analysts forecasts, post-earnings announcement drift, post-analyst forecast revisions drift, managers incentives

JEL Classification: G11, G14

Suggested Citation

Angelini, Paolo and Guazzarotti, Giovanni, Information Uncertainty and the Reaction of Stock Prices to News (July 30, 2010). Bank of Italy Temi di Discussione (Working Paper) No. 765, Available at SSRN: https://ssrn.com/abstract=1699627 or http://dx.doi.org/10.2139/ssrn.1699627

Paolo Angelini (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Giovanni Guazzarotti

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

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