Loss-Aversion Discount on Earnings News
39 Pages Posted: 10 Nov 2016
Date Written: November 8, 2016
This study tests and finds that stock prices around earnings announcements reflect investor aversion to negative news. We find that when forecasts are negatively skewed, indicating considerable downside risk, earnings announcement returns are eventually more positive. Announcement returns are also positive after controlling for the effect of negative forecast skewness on earnings expectations and earnings surprise. Our results suggest the increase in the likelihood of large negative earnings news causes investors not only to lower their earnings expectations, but also to impose an additional price discount. When earnings are announced and uncertainty is resolved, the discount is removed and announcement returns are positive. By contrast, positive skewness in earnings forecasts does not affect announcement returns. Taken together, the evidence suggests investors assign higher discounts to negative uncertainty than to positive uncertainty. The results imply that to lower cost of equity, firms should be concerned more with resolving negative than positive uncertainty.
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