Underreaction Associated with Return Extrapolation: Evidence from Post-earnings-announcement Drift

Abstract

Using novel data from a stock forum, we investigate return extrapolation in the cross-section. Our findings indicate that extrapolators overreact to stock returns but underreact to fundamental information. The post-earnings-announcement drift (PEAD) is more pronounced among firms with a high firm-level degree of extrapolation (DOX). Moreover, investors allocate more attention to returns and less to fundamentals for high-DOX firms. The relation between DOX and PEAD is stronger when investor attention to fundamentals is relatively low. Extrapolation also reduces stock price informativeness due to investors’ inattention to fundamentals. These findings support explanations of extrapolation based on limited asymmetric attention.

Keywords: Return Extrapolation, Post-earnings-announcement drift, Underreaction, Limited Attention

JEL Classification: G11, G12, G14