How Is Earnings News Transmitted to Stock Prices?
53 Pages Posted: 1 Nov 2017 Last revised: 5 Sep 2018
Date Written: August 7, 2018
We study price formation around earnings announcements for S&P 1500 stocks from 2011 to 2015 to understand the relationship between liquidity and price efficiency. Earnings are announced in the after-hours market, an illiquid trading environment with low trading volume. Spreads are wider before announcements and narrow more slowly after announcements for small firms. The narrowing of spreads is driven by one side of the quote as ask (bid) prices update instantaneously after positive (negative) news. On average, pre-announcement spreads include the post-announcement midquote, leaving no profits for liquidity traders other than trading against stale quotes. Midquote prices fully reflect earnings surprises before the opening of markets even if there are no trades.
Keywords: after-hours trading, earnings announcements, liquidity, order flow, price discovery
JEL Classification: G10, G12, G14
Suggested Citation: Suggested Citation