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Information uncertainty and the reaction of stock prices to news

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  • Paolo Angelini

    ()
    (Bank of Italy)

  • Giovanni Guazzarotti

    ()
    (Bank of Italy)

Abstract

Recent theoretical papers suggest that high uncertainty about firms’ economic prospects can explain delays in the adjustment of their stock prices to economic news. Using analyst forecast revisions and earnings announcements as proxies of news, we find mixed evidence in support of this hypothesis. We confirm that stocks of firms whose prospects are highly uncertain display a relatively large delayed price reaction (so-called continuation) after the release of news, but we argue that this evidence does not necessarily imply a slower adjustment speed. Indeed, for these stocks the immediate reaction to news is also relatively strong. In fact, the magnitude of the delayed price reaction (the price continuation) depends both on the degree of price sluggishness and on the “scale” of the news hitting the stock. We therefore consider both the delayed and immediate responses, and compute measures of adjustment speed that do not depend on the “scale” of the news. We then compare these measures across portfolios of stocks characterized by different degrees of uncertainty. Our findings indicate that: (i) stock prices characterized by high uncertainty tend to adjust to bad news more sluggishly than those characterized by low uncertainty; (ii) the opposite holds true in the case of good news; (iii) stock prices characterized by high uncertainty tend to adjust to bad news more sluggishly than to good news. Previous empirical literature focuses on price continuation patterns but neglects to control for the “scale” of the news, reaching erroneous conclusions.

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Bibliographic Info

Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 765.

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Date of creation: Jul 2010
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Handle: RePEc:bdi:wptemi:td_765_10

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Related research

Keywords: stock price continuation; price adjustment speed; news; earnings announcements; analysts forecasts; post-earnings announcement drift; post-analyst forecast revisions drift; managers incentives;

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