The Earnings Announcement Return Cycle
42 Pages Posted: 8 Jun 2018
Date Written: May 22, 2018
Stocks earn negative abnormal returns before earnings announcements and positive after them. An "earnings announcement return cycle" (EARC) strategy earns a four-factor alpha of 8.5% per year (t-value = 6.12). The EARC is unrelated to the earnings announcement premium, and it is a feature of stocks widely covered by analysts. Analysts' forecasts follow the same pattern as returns: analysts’ forecasts become more optimistic after an earnings announcement and more pessimistic as the next one draws near. We attribute one-half of the earnings announcement return cycle to this “optimism cycle.” The EARC may stem from mispricing. Both the average return and optimism patterns are stronger among high-uncertainty and difficult-to-arbitrage stocks, and the EARC strategy is more profitable on days when it would accommodate larger amounts of arbitrage capital.
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