Liquidity and the Post-Earnings-Announcement Drift

Abstract

The post-earnings-announcement-drift is a long standing anomaly that is in conflict with market efficiency. This paper documents that the post-earnings-announcement drift occurs mainly in the highly illiquid stocks. A trading strategy that goes long the high earnings surprise stocks and short the low earnings surprise stocks provides a value-weighted return of 0.14% in the most liquid stocks and 1.60% per month in the most illiquid stocks. The illiquid stocks have high trading costs and market impact costs. Using a multitude of estimates we find that transaction costs account for anywhere from 63% to 100% of the paper profits from the long-short strategy designed to exploit the earnings momentum anomaly. This paper provides support for the argument that transactions costs could be the source of the drift.

Keywords: G11, G12, C11