Asymmetric Trading Costs Prior to Earnings Announcements: Implications for Price Discovery and Returns

56 Pages Posted: 2 Apr 2014 Last revised: 11 Jan 2017

Travis L. Johnson

The University of Texas at Austin - Department of Finance

Eric C. So

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Date Written: January 10, 2017

Abstract

We show the cost of trading on negative news relative to positive news increases prior to earnings announcements. Our evidence suggests this asymmetry is due to financial intermediaries reducing their exposure to announcement risks by providing liquidity asymmetrically. The asymmetry creates a predictable upward bias in price discovery and returns that increases pre-announcement and subsequently reverses, confounding short-window announcement returns as measures of earnings news and risk premia. Our findings provide a link between trading behavior, return patterns, and the information content of prices around earnings announcements, and help explain several puzzling results in prior research. Finally, we provide evidence that our frictions-based theory helps explain well-documented patterns in Friday asset returns and earnings announcement timing.

Keywords: Earnings announcements, announcement premia, liquidity, market making, intermediaries

JEL Classification: G10, G11, G12, G14, M41

Suggested Citation

Johnson, Travis L. and So, Eric C., Asymmetric Trading Costs Prior to Earnings Announcements: Implications for Price Discovery and Returns (January 10, 2017). Available at SSRN: https://ssrn.com/abstract=2419284 or http://dx.doi.org/10.2139/ssrn.2419284

Travis L. Johnson (Contact Author)

The University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States

HOME PAGE: http://faculty.mccombs.utexas.edu/johnson

Eric C. So

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States

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