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Inflation Illusion and Post-Earnings-Announcement Drift

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  • TARUN CHORDIA
  • LAKSHMANAN SHIVAKUMAR
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    Abstract

    This paper examines the cross-sectional implications of the inflation illusion hypothesis for the post-earnings-announcement drift. The inflation illusion hypothesis suggests that stock market investors fail to incorporate inflation in forecasting future earnings growth rates, and this causes firms whose earnings growths are positively (negatively) related to inflation to be undervalued (overvalued). We argue and show that the sensitivity of earnings growth to inflation varies monotonically across stocks sorted on standardized unexpected earnings (SUE) and, consistent with the inflation illusion hypothesis, show that lagged inflation predicts future earnings growth, abnormal returns, and earnings announcement returns of SUE-sorted stocks. Interestingly, controlling for the return predictive ability of inflation weakens the ability of lagged SUE to predict future returns of SUE-sorted stocks. Copyright 2005 The Institute of Professional Accounting, University of Chicago.

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    Bibliographic Info

    Article provided by Wiley Blackwell in its journal Journal of Accounting Research.

    Volume (Year): 43 (2005)
    Issue (Month): 4 (09)
    Pages: 521-556

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    Handle: RePEc:bla:joares:v:43:y:2005:i:4:p:521-556

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    Cited by:
    1. François Dossou & Sandrine Lardic & Karine Michalon, 2008. "Can earnings forecasts be improved by taking into account the forecast bias?," Post-Print halshs-00365972, HAL.
    2. Truong, Cameron, 2010. "Post earnings announcement drift and the roles of drift-enhanced factors in New Zealand," Pacific-Basin Finance Journal, Elsevier, vol. 18(2), pages 139-157, April.
    3. Richardson, Scott & Tuna, Irem & Wysocki, Peter, 2010. "Accounting anomalies and fundamental analysis: A review of recent research advances," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 410-454, December.
    4. Basak, Suleyman & Yan, Hongjun, 2009. "Equilibrium Asset Prices and Investor Behavior in the Presence of Money Illusion," CEPR Discussion Papers 7398, C.E.P.R. Discussion Papers.
    5. Li Gu & Dayong Huang, 2013. "Consumption, Money, Intratemporal Substitution, And Cross-Sectional Asset Returns," Journal of Financial Research, Southern Finance Association & Southwestern Finance Association, vol. 36(1), pages 115-146, 01.
    6. repec:ebl:ecbull:v:7:y:2008:i:11:p:1-20 is not listed on IDEAS
    7. Min, Byoung-Kyu & Kim, Tong Suk, 2012. "Are good-news firms riskier than bad-news firms?," Journal of Banking & Finance, Elsevier, vol. 36(5), pages 1528-1535.
    8. Konchitchki, Yaniv, 2011. "Inflation and Nominal Financial Reporting: Implications for Performance and Stock Prices," MPRA Paper 52928, University Library of Munich, Germany.
    9. Konchitchki, Yaniv, 2013. "Accounting and the Macroeconomy: The Case of Aggregate Price-Level Effects on Individual Stocks," MPRA Paper 52934, University Library of Munich, Germany.
    10. Carlos Forner & Sonia Sanabria & Joaquín Marhuenda, 2009. "Post-earnings announcement drift: Spanish evidence," Spanish Economic Review, Springer, vol. 11(3), pages 207-241, September.
    11. Chordia, Tarun & Shivakumar, Lakshmanan, 2006. "Earnings and price momentum," Journal of Financial Economics, Elsevier, vol. 80(3), pages 627-656, June.
    12. Chen, Hong-Yi & Chen, Sheng-Syan & Hsin, Chin-Wen & Lee, Cheng-Few, 2014. "Does revenue momentum drive or ride earnings or price momentum?," Journal of Banking & Finance, Elsevier, vol. 38(C), pages 166-185.
    13. Gu, Li & Huang, Dayong, 2010. "Sales order backlogs and momentum profits," Journal of Banking & Finance, Elsevier, vol. 34(7), pages 1564-1575, July.

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