An Analytical Measure of Market Underreaction to Earnings News

30 Pages Posted: 15 Mar 2014 Last revised: 27 Nov 2018

See all articles by Kee H. Chung

Kee H. Chung

State University of New York at Buffalo - School of Management

Oliver Kim

University of Maryland

Steve C. Lim

Texas Christian University - M.J. Neeley School of Business

Sean Yang

Oregon State University - College of Business

Date Written: November 27, 2018

Abstract

Prior studies have provided a number of possible explanations for delayed market reactions to earnings announcements. However, there has been relatively little effort to predict the magnitude of the post-earnings announcement drift (PEAD). We show that the squared correlation coefficient (p2 ) between order imbalance and earnings surprise determines the magnitude of market underreaction to earnings surprises and PEAD = k p2, where k is the information content of earnings. We discuss several testable implications of our analytical results, including a model-implied measure of information asymmetry that arises from the differential information processing ability of traders.

Keywords: Strategic trading, Information asymmetry, Information precision, Liquidity demander, Liquidity provider, Order imbalance, Information content, Price impact

JEL Classification: G14

Suggested Citation

Chung, Kee H. and Kim, Oliver and Lim, Steve and Yang, Sean, An Analytical Measure of Market Underreaction to Earnings News (November 27, 2018). Available at SSRN: https://ssrn.com/abstract=2409124 or http://dx.doi.org/10.2139/ssrn.2409124

Kee H. Chung (Contact Author)

State University of New York at Buffalo - School of Management ( email )

Buffalo, NY 14260
United States
716-645-3262 (Phone)
716-645-3823 (Fax)

HOME PAGE: http://mgt.buffalo.edu/faculty/academic-departments/finance/faculty/kee-chung.html

Oliver Kim

University of Maryland ( email )

Rm.4449, Van Munching Hall
College Park, MD 20742-1815
United States
301-405-2243 (Phone)

Steve Lim

Texas Christian University - M.J. Neeley School of Business ( email )

2900 Lubbock Street
Fort Worth, TX 76129
United States
817-257-7536 (Phone)

Sean Yang

Oregon State University - College of Business ( email )

Corvallis, OR 97331
United States

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