A Tough Act to Follow: Contrast Effects in Financial Markets
61 Pages Posted: 3 Jun 2015 Last revised: 4 Oct 2017
Date Written: September 21, 2017
A contrast effect occurs when the value of a previously-observed signal inversely biases perception of the next signal. We present the first evidence that contrast effects can distort prices in sophisticated and liquid markets. Investors mistakenly perceive earnings news today as more impressive if yesterday’s earnings surprise was bad and less impressive if yesterday’s surprise was good. A unique advantage of our financial setting is that we can identify contrast effects as an error in perceptions rather than expectations. Finally, we show that our results cannot be explained by a key alternative explanation involving information transmission from previous earnings announcements.
Keywords: contrast effects, behavioral economics, relative thinking, financial markets
JEL Classification: G02, D03, G14
Suggested Citation: Suggested Citation