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Under-or-overreaction: Market responses to announcements of earnings surprises

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  • Alwathnani, Abdulaziz M.
  • Dubofsky, David A.
  • Al-Zoubi, Haitham A.

Abstract

We test whether the well-documented market reaction to the announcements of earnings surprises is a manifestation of an investor underreaction or overreaction to extremely good or bad earnings news. Using the market reaction in the three-day period surrounding the announcements of extreme earnings surprises (i.e., SUE) in quarter Qt as a reference point, we show that firms reporting a high (low) SUE in subsequent quarter Qt+1 that confirms their initial quarter Qt SUE ranking in the same highest or lowest SUE quintiles generate an incremental price run that moves in the same direction as that of the initial SUE. However, the price impact of the confirming SUE signal is weaker than that of its initial SUE. Our findings are robust to the Fama-French three-factor daily regression extended by the momentum factor and a number of other robustness tests. Our result is not consistent with the prevalent view that investors underreact to earnings news. To the contrary, the evidence suggests an initial investor overreaction to extreme SUE signals.

Suggested Citation

  • Alwathnani, Abdulaziz M. & Dubofsky, David A. & Al-Zoubi, Haitham A., 2017. "Under-or-overreaction: Market responses to announcements of earnings surprises," International Review of Financial Analysis, Elsevier, vol. 52(C), pages 160-171.
    • Handle: RePEc:eee:finana:v:52:y:2017:i:c:p:160-171
    DOI: 10.1016/j.irfa.2017.07.006
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    3. Jose I. Alvarado & Lindsay C. Clark & Jose A. Gutierrez, 2021. "Stock performance subsequent to combinations in quarterly revenue surprise, earnings surprise, guidance, valuation, and report time," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 45(1), pages 95-117, January.
    4. Borgards, Oliver & Czudaj, Robert L. & Hoang, Thi Hong Van, 2021. "Price overreactions in the commodity futures market: An intraday analysis of the Covid-19 pandemic impact," Resources Policy, Elsevier, vol. 71(C).

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    More about this item

    Keywords

    Earnings surprise; Initial SUE; Confirming SUE signals; Disconfirming SUE evidence; Overreaction; Price reversals;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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