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Implications of Transaction Costs for the Post-Earnings-Announcement Drift

55 Pages Posted: 2 May 2006 Last revised: 18 Apr 2013

Jeffrey Ng

Hong Kong Polytechnic University - School of Accounting and Finance

Tjomme O. Rusticus

University of Minnesota

Rodrigo S. Verdi

Massachusetts Institute of Technology (MIT)

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Date Written: October 2007

Abstract

This paper examines the effect of transaction costs on the post-earnings-announcement drift (PEAD). Using standard market microstructure features we show that transaction costs constrain the informed trades that are necessary to incorporate earnings information into price. This leads to weaker return responses at the time of the earnings announcement and higher subsequent returns drift for firms with high transaction costs. Consistent with this prediction, we find that earnings response coefficients are lower for firms with higher transaction costs. Using portfolio analyses, we find that the profits of implementing the PEAD trading strategy are significantly reduced by transaction costs. In addition, we show, using a combination of portfolio and regression analyses, that firms with higher transaction costs are the ones that provide the higher abnormal returns for the PEAD strategy. Our results indicate that transaction costs can provide an explanation not only for the persistence but also for the existence of PEAD.

Keywords: market efficiency, transaction costs, post-earnings announcement drift

JEL Classification: G12, G14, M41

Suggested Citation

Ng, Jeffrey and Rusticus, Tjomme O. and Verdi, Rodrigo S., Implications of Transaction Costs for the Post-Earnings-Announcement Drift (October 2007). Available at SSRN: https://ssrn.com/abstract=899902 or http://dx.doi.org/10.2139/ssrn.899902

Jeffrey Ng

Hong Kong Polytechnic University - School of Accounting and Finance ( email )

Hung Hom
Kowloon
Hong Kong

Tjomme O. Rusticus (Contact Author)

University of Minnesota ( email )

Carlson School of Management
321 19th Avenue South, Room 3-122
Minneapolis, MN 55455
United States

Rodrigo S. Verdi

Massachusetts Institute of Technology (MIT) ( email )

Sloan School of Management
100 Main Street E62-666
Cambridge, MA 02142
United States
(617) 253 2956 (Phone)

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