When Good News Is Not So Good: Economy‐wide Uncertainty and Stock Returns

This paper shows that variation in economy‐wide uncertainty causes asymmetric stock price responses to firm earnings surprises. The uncertainty that attends bad earnings news that arrives during expansions with greater economy‐wide uncertainty occasions larger price declines. This is because news inconsistent with investors’ prior beliefs about the state of the economy increases uncertainty, which amplifies the negative cash flow effects contained in bad earnings news. Asymmetrically, the positive cash flow effect of good earnings news that arrives during recessions is offset by increased investor uncertainty, which results in relatively smaller price reactions to the good news. This is consistent with Veronesi's rational expectations equilibrium model, which shows that investors demand higher expected returns in the face of greater uncertainty.     

Market Response to Investor Sentiment

This paper reconsiders the effect of investor sentiment on stock prices. Our main contribution is that, in addition to the intermediate term return predictability, we also analyze the immediate price reaction to the publication of survey‐based investor sentiment indicators. We find that the sign of the immediate market response is the same as that of the predictability at intermediate time horizons. This is consistent with underreaction to cash flow news or with investor sentiment being related to mispricing. It is inconsistent with the alternative explanations of a rational response to cash flow news or sentiment indicators providing information about future expected returns.     

Too Good to be True? An Analysis of the Options Market's Reactions to Earnings Releases

Using option implied risk neutral return distributions before and after earnings announcements, we study the option market's reaction to extreme events over earnings announcements. While earnings announcements generally reduce short‐term uncertainty about the stock price, very good news does not reduce uncertainty and slightly bad news actually increases uncertainty. We also find that left tail probabilities decrease over earnings releases while right tail probabilities increase. We interpret these findings as evidence of maintained investor expectations that very good news is generally not released during earnings announcements, combined with skepticism in the form of lingering uncertainty at the release of such very good news.     

Reversal and momentum patterns in weekly stock returns: European evidence

We analyze short‐term reversal and medium‐term momentum patterns in weekly stock returns in Europe. Focusing on raw and stock‐specific returns, our empirical results show for both return specifications (a) a negative relation between weekly past returns and future returns in the short run and (b) a positive relation in the medium run. However, returns from reversal and momentum strategies based on stock‐specific returns are less volatile. In further analyses, we find short‐term reversal and medium‐term momentum patterns to be connected to stock characteristics. Looking at the potential causes of these effects, our results do not support the idea that short‐term reversal in weekly stock returns is due to an over‐ or underreaction to firm‐specific news nor that it is mainly driven by illiquidity. Medium‐term momentum in weekly stock returns, on the other hand, can be connected to behavioral biases. Our concluding tests confirm that our findings are robust among industries, in subperiods, for the January effect and in varying market states. Finally, while medium‐term momentum strategies remain profitable after accounting for transaction costs, short‐term reversal strategies can be mainly explained by transaction costs due to their high turnover.     

Stock‐Split Post‐Announcement Returns: Underreaction or Market Friction?

We explore the relationship between stock splits and subsequent long‐term returns during the period from 1950 to 2000. We find that, contrary to much previous research, firms do not exhibit positive long‐term post‐split returns. Instead, we find that significant positive returns after the announcement date do not persist after the actual date of the stock split. We also observe that abnormal returns are correlated with the price‐delay or market friction. We conclude that the stock‐split post‐announcement “drift” is only of short duration, and it is attributable to trading frictions rather than behavioral biases.     

Sentiment stocks

To study how investor sentiment at the firm level affects stock returns, we match more than 58 million social media messages in China with listed firms and construct a measure of individual stock sentiment based on the tone of those messages. We document that positive investor sentiment predicts higher stock risk-adjusted returns in the very short term followed by price reversals. This association between stock sentiment and stock returns is not explained by observable stock characteristics, unobservable time-invariant characteristics, market-wide sentiment, overreaction to news, or changing investor attention. Consistent with theories of investor sentiment, we find that the link between sentiment and stock returns is mainly driven by positive sentiment and non-professional investors. Finally, exploiting a unique feature of the Chinese stock market, we are able to isolate the causal effect of sentiment on stock returns from confounding factors.     

Investment Horizon and Repo in the Over‐the‐Counter Market

This paper presents a three‐period model featuring a short‐term investor in the over‐the‐counter bond market. A short‐term investor stores cash because of a need to pay cash at some future date. If a short‐term investor buys bonds, then a deadline for retrieving cash lowers the resale price of bonds for the investor through bilateral bargaining in the bond market. Ex‐ante, this hold‐up problem explains the use of a repo by a short‐term investor, the existence of a haircut, and the vulnerability of a repo market to counterparty risk. This result holds without any uncertainty about bond returns or asymmetric information.     

Stock price synchronicity,cognitive biases,and momentum

The momentum anomaly is widely attributed to investor cognitive biases, but the trigger of cognitive biases is largely unexplored. In this study, inspired by psychology studies linking cognitive biases to the noisiness of information, we examine whether momentum returns are associated with high stock price synchronicity, a manifestation of noisy firm-specific information. Our results demonstrate that momentum is more pronounced in the presence of high stock price synchronicity. This finding is robust to other explanations and firm characteristics. We also find that stock price synchronicity boosts the profitability of momentum by amplifying investor underreaction to new information.     

The Credibility of Voluntary Disclosure and Insider Stock Transactions

We examine stock price reaction to voluntary disclosure of innovation strategy by high‐tech firms and its relation with insider stock transactions before the disclosure. We find that, despite the qualitative and subjective nature of strategy‐related disclosure, there is positive stock price reaction to the disclosure. The evidence suggests that investors view the disclosure as credible good news. We also find that the disclosure is associated with more positive stock price reaction when it is preceded by insider purchase transactions. This evidence is consistent with insider purchase enhancing the credibility of the disclosure. The credibility‐enhancing effect is found to be stronger for firms with higher degrees of information asymmetry (younger firms, firms with lower analyst following, loss firms, and firms with higher research and development (R&D) intensity). Our evidence also indicates that predisclosure insider purchase is associated with greater future abnormal returns, suggesting that managers are privy to good news shortly before the disclosure.     

Voluntary Disclosures,Corporate Control,and Investment

We examine the valuation and capital allocation roles of voluntary disclosure when managers have private information regarding the firm’s investment opportunities, but an efficient market for corporate control influences their investment decisions. For managers with long‐term stakes in the firm, the equilibrium disclosure region is two‐tailed: only extreme good news and extreme bad news is disclosed in equilibrium. Moreover, the market’s stock price and investment responses to bad news disclosures are stronger than the responses to good news disclosures, which is consistent with the empirical evidence. We also find that myopic managers are more likely to withhold bad news in good economic times when markets can independently assess expected investment returns.     

SENSITIVITY OF INVESTOR REACTION TO MARKET DIRECTION AND VOLATILITY: DIVIDEND CHANGE ANNOUNCEMENTS

We examine whether investor reactions are sensitive to the recent direction or volatility of underlying market movements. We find that dividend change announcements elicit a greater change in stock price when the nature of the news (good or bad) goes against the grain of the recent market direction during volatile times. For example, announcements to lower dividends elicit a significantly greater decrease in stock price when market returns have been up and more volatile. Similarly, announcements to raise dividends tends to elicit a greater increase in stock price when market returns have been normal or down and more volatile, although this latter tendency lacks statistical significance. We suggest an explanation for these results that combines the implications of a dynamic rational expectations equilibrium model with behavioral considerations that link the responsiveness of investors to market direction and volatility.     

The Long-Lasting Momentum in Weekly Returns

Reversal is the current stylized fact of weekly returns. However, we find that an opposing and long‐lasting continuation in returns follows the well‐documented brief reversal. These subsequent momentum profits are strong enough to offset the initial reversal and to produce a significant momentum effect over the full year following portfolio formation. Thus, ex post, extreme weekly returns are not too extreme. Our findings extend to weekly price movements with and without public news. In addition, there is no relation between news uncertainty and the momentum in 1‐week returns.     

Investor sentiment and management earnings forecast bias

This study investigates whether investor sentiment is associated with behavioral bias in managers’ annual earnings forecasts that are generally issued early in the year when uncertainty is relatively high. I provide evidence that management earnings forecast optimism increases with investor sentiment. Furthermore, I find that managers’ annual earnings forecasts are more pessimistic during low‐sentiment periods than during normal‐sentiment periods. Since managers lack incentives to further deflate stock prices during a low‐sentiment period, this evidence indicates that sentiment‐related management earnings forecast bias is likely to be unintentional. In addition, I find that the relationship between management earnings forecast bias and investor sentiment is stronger for firms with higher uncertainty, consistent with investor sentiment having a greater influence on management earnings forecasts when uncertainty is higher.     

Information salience,investor sentiment,and stock returns: The case of British soccer betting

Soccer clubs listed on the London Stock Exchange provide a unique way of testing stock price reactions to different types of news. For each firm, two pieces of information are released on a weekly basis: experts' expectations about game outcomes through the betting odds, and the game outcomes themselves. The stock market reacts strongly to news about game results, generating significant abnormal returns and trading volumes. We find evidence that the abnormal returns for the winning teams do not reflect rational expectations but are high due to overreactions induced by investor sentiment. This is not the case for losing teams. There is no market reaction to the release of new betting information although these betting odds are excellent predictors of the game outcomes. The discrepancy between the strong market reaction to game results and the lack of reaction to betting odds may not only be the result from overreaction to game results but also from the lack of informational content or information salience of the betting information. Therefore, we also examine whether betting information can be used to predict short-run stock returns subsequent to the games. We reach mixed results: we conclude that investors ignore some non-salient public information such as betting odds, and betting information predicts a stock price overreaction to game results which is influenced by investors' mood (especially when the teams are strongly expected to win).     

The roles of past returns and firm fundamentals in driving US stock price movements

This paper provides new empirical evidence that incorporating past stock returns from different time horizons can enhance the ability of firm fundamentals to better explain stock price movements but this benefit dissipates under uncertainty. We apply both OLS and state-space modeling to US firms' stock price movements over the period from 1999 to 2012 to compare the roles of the two main types of information typically used by equity investors. Empirical results reveal the importance of firm fundamentals over longer term horizons for particularly, small-cap stocks with greater information uncertainty. Furthermore, when market uncertainty is high, fundamentals unambiguously dominate in driving stock price movements of smaller sized firms indicating that uncertainty at the firm and market level both create attention bias on firm fundamentals.     

Earnings Announcements,Differences of Opinion and Management Guidance

Berkman, Dimitrov, Jain, Koch, and Tice (2009) document a negative relationship between differences of opinion and earnings announcement returns, and this relationship is more pronounced when short‐sale constraints are likely to be high. These findings are interpreted as support for the theory in Miller (1977) that binding short sale constraints cause pessimists to be underrepresented in price formation. We conjecture that accounting information (i.e., earnings news) is likely to play a role in this returns pattern. After controlling for the level of earnings news, we find that the relationship between differences of opinion and stock returns is either eliminated or opposite from what is predicted by Miller's theory. Further, we present evidence that suggests the confounding effect of earnings news can be explained by (pessimistic) management earnings guidance. Our findings offer an alternative explanation for why low differences of opinion stocks earn greater abnormal returns around earnings announcements.     

When is a MAX not the MAX? How news resolves information uncertainty

A well-known asset pricing anomaly, the “MAX” effect, measured by the maximum daily return in the past month, depicts stocks’ lottery-like features and investor gambling behaviour. Using the comprehensive stock-level Dow Jones (DJNS) news database between 1979 and 2016, we consider in a empirical setting how the presence of news reports affects these lottery-type stocks. We find an augmented negative relationship between MAX stocks without news and expected returns, whereby MAX with news coverage generates return momentum. The differing future return relationships between MAX stocks with and without news appears to be best explained by information uncertainty mitigation upon news arrival. Overall, our findings suggest that news plays a role in resolving information uncertainty in the stock market.     

Investor protection and price informativeness about future earnings: international evidence

This study draws on the investor protection literature to identify structural factors in a country’s information environment that are likely to explain cross-country differences in the extent to which future earnings information is capitalized in current stock returns. Using a sample of 55,900 firm-years from 32 countries, we find that greater financial disclosure, higher quality earnings, and greater information dissemination through news media are associated with stock prices that are more informative about future earnings, whereas strong enforcement of insider trading laws is associated with stock prices that are less informative about future earnings. We also find that, on average, price informativeness about future earnings is greater in countries with strong investor protection. Our results illuminate the importance of structural factors constituting a country’s information environment in explaining cross-country variation in price informativeness about future earnings.     

Anticipated Earnings Announcements and the Customer–Supplier Anomaly

I test whether the anticipation of earnings news stimulates acquisition of customer information and mitigates returns to the customer–supplier anomaly documented by Cohen and Frazzini (“Economic Links and Predictable Returns.” The Journal of Finance 63 (2008): 1977–2011). I find that attention to a firm's publicly disclosed customers increases shortly before the firm announces earnings, and that customer stock returns predict supplier stock returns shortly before, but not after, the supplier's earnings announcement. I further find some evidence that these predictable returns are increasing in the level of customer information acquisition. These results are unique to anticipated disclosure events and suggest that anticipation of supplier earnings announcements resolves investor limited attention to customer information and accelerates price discovery of customer news.