How Is Earnings News Transmitted to Stock Prices?
49 Pages Posted: 1 Nov 2017 Last revised: 10 Apr 2019
Date Written: April 8, 2019
Most firm-level news is announced in the after-hours market, a very illiquid trading environment. We study price formation around earnings announcements to understand the relationship between liquidity and market efficiency in this environment. Price discovery occurs through changes in quotes, not through trading. Pre-announcement bid-ask spreads are wide enough to eliminate profits of informed liquidity-takers. Spreads narrow following announcements but do so asymmetrically: ask (bid) prices adjust quickly and efficiently reflect positive (negative) surprises while bid (ask) prices are slower to adjust. This asymmetry generates midquote price drifts, highlighting limitations of using midquotes for examining price discovery of illiquid assets.
Keywords: after-hours trading, earnings announcements, liquidity, order flow, price discovery
JEL Classification: G10, G12, G14
Suggested Citation: Suggested Citation