A New Metric of Market Underreaction to Earnings Announcements: An Empirical Test
44 Pages Posted: 14 Jan 2018 Last revised: 3 Oct 2018
Date Written: September 24, 2018
This paper tests the empirical validity of an analytical measure of market underreaction to earnings surprise. Chung, Kim, Lim, and Yang (2018) analytically show that the squared correlation coefficient between order imbalance and earnings surprise (COE) measures market underreaction and predicts the post-earnings-announcement drift (PEAD). We find strong evidence that COE during the announcement period predicts price movements (returns) during the post-announcement period in the expected direction. We find qualitatively similar results using risk adjusted returns (i.e., Fama-French, Carhardt, and Pastor-Stambaugh factor alphas), suggesting that well-known risk factors do not explain the profitability of trading strategy based on COE.
Keywords: strategic arbitrage, information asymmetry, market underreaction, liquidity demander, liquidity provider, order imbalance
JEL Classification: G14
Suggested Citation: Suggested Citation