Post-earnings-announcement drift (PEAD) refers to the tendency of a stock’s return to drift for several monthly following publications of earnings results (Sadka, 2006). Ball & Brown discovered this anomaly in 1968, where they argued that investors tend to underreact to the information content of earnings. This explains why firms with high-standardized unexpected earnings (SUE) outperform low SUE companies. It is also worth noting that the persistence of this anomaly raises serious concerns regarding the efficient market hypothesis. Whilst academics fully understand the consequences of PEAD, there remain doubts and disagreements regarding the causes of the effect. The following part will critically analyze empirical evidence in order to identify
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Similarly to FOS, they also noted an inverse relationship between firm size and post earnings drift. On one hand, they were not able to identify the role of asset pricing factors in identifying the drift and rejected BKW’s claim of shifting betas since its magnitude is not significant enough to full explain the drift. The assumptions required to reconcile evidence with the CAPM approach were judged to be implausible. On the other hand, BT noticed some evidence supporting the delayed response approach. Indeed, most of the drift is constrained by an upper bound, with some excess returns surpassing the transaction costs. BT later commented that the transaction costs argument therefore does not explain the entire drift. The explanation for this was summarized in two points; the first states that, “even if transaction costs causes ‘sluggishness’ in prices, it was still hard to understand why the resulting mispricing lasted for months” (Bernard and Thomas, 1989). The second stated why information can’t be impounded in prices by traders for whom transaction costs are low or irrelevant (irrelevant because traders are committed to trade). Such an explanation indicates why the PEAD effect is not fully explainable in terms of transaction …show more content…
Indeed, assuming investors are aware of the PEAD effect, they could take advantage of such anomaly in order to profit (Shleifer and Vishny, 1997). This is in line with the methodological flaws explanation, arguing that, since the cause of the drift is investor’s naivety, arbitragers should eliminate the effect over time, enforcing efficient markets in the long run. However, Schleifer and Vishny (1997) identified that real world arbitrage is risky and argue that this risk combined with high transaction costs impede arbitrageurs. Such hypothesis explains why the drift has been so consistent over the years further imposing doubts regarding the market efficiency
Similarly to FOS, they also noted an inverse relationship between firm size and post earnings drift. On one hand, they were not able to identify the role of asset pricing factors in identifying the drift and rejected BKW’s claim of shifting betas since its magnitude is not significant enough to full explain the drift. The assumptions required to reconcile evidence with the CAPM approach were judged to be implausible. On the other hand, BT noticed some evidence supporting the delayed response approach. Indeed, most of the drift is constrained by an upper bound, with some excess returns surpassing the transaction costs. BT later commented that the transaction costs argument therefore does not explain the entire drift. The explanation for this was summarized in two points; the first states that, “even if transaction costs causes ‘sluggishness’ in prices, it was still hard to understand why the resulting mispricing lasted for months” (Bernard and Thomas, 1989). The second stated why information can’t be impounded in prices by traders for whom transaction costs are low or irrelevant (irrelevant because traders are committed to trade). Such an explanation indicates why the PEAD effect is not fully explainable in terms of transaction …show more content…
Indeed, assuming investors are aware of the PEAD effect, they could take advantage of such anomaly in order to profit (Shleifer and Vishny, 1997). This is in line with the methodological flaws explanation, arguing that, since the cause of the drift is investor’s naivety, arbitragers should eliminate the effect over time, enforcing efficient markets in the long run. However, Schleifer and Vishny (1997) identified that real world arbitrage is risky and argue that this risk combined with high transaction costs impede arbitrageurs. Such hypothesis explains why the drift has been so consistent over the years further imposing doubts regarding the market efficiency