Off-Exchange Trading and Post Earnings Announcement Drift

57 Pages Posted: 1 Aug 2018 Last revised: 7 Aug 2019

See all articles by Jacob K. Thomas

Jacob K. Thomas

Yale School of Management

Frank Zhang

Yale School of Management

Wei Zhu

University of Illinois at Urbana-Champaign - Department of Accountancy

Date Written: June 30, 2019

Abstract

Off-exchange trading, which tends to attract uninformed trades, accounts for 35 percent of trading volume today. Microstructure theory suggests that taking uninformed trades off exchanges harms liquidity but improves price discovery prior to public information release. We examine how this trade-off affects a longstanding anomaly suggesting investor underreaction: price drifts after earnings announcements. The liquidity (price discovery) channel predicts that off-exchange trading increases (decreases) underreaction. Our results, based on investigation of a large panel of US firms and a natural experiment created by the SEC’s Tick Size Pilot program, suggest the liquidity channel dominates. The negative effects of off-exchange trading on liquidity (less depth and wider spreads) likely increase arbitrage costs, thereby increasing residual underreaction. We find that the positive relation between off-exchange trading and underreaction remains strong even after we control for a host of observable arbitrage cost measures. Levels of off-exchange trading proxy well for hard-to-measure arbitrage costs.

Keywords: Off-exchange trading; Post-earnings-announcement-drift; Limits to arbitrage; Liquidity; Price discovery; Price efficiency

JEL Classification: G12; G14

Suggested Citation

Thomas, Jacob Kandathil and Zhang, Frank and Zhu, Wei, Off-Exchange Trading and Post Earnings Announcement Drift (June 30, 2019). 29th Annual Conference on Financial Economics & Accounting 2018. Available at SSRN: https://ssrn.com/abstract=3223528 or http://dx.doi.org/10.2139/ssrn.3223528

Jacob Kandathil Thomas

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

Frank Zhang

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

Wei Zhu (Contact Author)

University of Illinois at Urbana-Champaign - Department of Accountancy ( email )

1206 South Sixth Street
Champaign, IL 61820
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
106
Abstract Views
847
rank
255,010
PlumX Metrics