A New Metric of Market Underreaction to Earnings Announcements: An Empirical Test

44 Pages Posted: 14 Jan 2018 Last revised: 3 Oct 2018

See all articles by Kee H. Chung

Kee H. Chung

State University of New York at Buffalo - School of Management

Oliver Kim

University of Maryland

Steve C. Lim

Texas Christian University - M.J. Neeley School of Business

Sean Yang

State University of New York at Buffalo - School of Management

Date Written: September 24, 2018

Abstract

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

Chung, Kee H. and Kim, Oliver and Lim, Steve and Yang, Sean, A New Metric of Market Underreaction to Earnings Announcements: An Empirical Test (September 24, 2018). Available at SSRN: https://ssrn.com/abstract=3101491 or http://dx.doi.org/10.2139/ssrn.3101491

Kee H. Chung

State University of New York at Buffalo - School of Management ( email )

Buffalo, NY 14260
United States
716-645-3262 (Phone)
716-645-3823 (Fax)

HOME PAGE: http://mgt.buffalo.edu/faculty/academic-departments/finance/faculty/kee-chung.html

Oliver Kim

University of Maryland ( email )

Rm.4449, Van Munching Hall
College Park, MD 20742-1815
United States
301-405-2243 (Phone)

Steve Lim (Contact Author)

Texas Christian University - M.J. Neeley School of Business ( email )

2900 Lubbock Street
Fort Worth, TX 76129
United States
817-257-7536 (Phone)

Sean Yang

State University of New York at Buffalo - School of Management ( email )

Jacobs Management Center
Buffalo, NY 14222
United States

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