Earnings announcement premium and return volatility: Is it consistent with risk-return trade-off?

Abstract

Earlier studies document the earnings announcement premium, that the average stock return around earnings announcements is positive. This study examines the earnings announcement premium with a focus on the relationship between stock returns and return volatilities. Our findings can be summarized as follows. First, based on the long-term data including the post financial crisis period, we find that the earnings announcement premium still exists, positive and significant. Second, the announcement premium is positively related to the expected volatility. The positive relationship between the announcement premium and the expected volatility indicates a risk-return tradeoff, suggesting that investors hold on to their stocks expecting that their taking risk is compensated with returns. Third, we find that the announcement premium is inversely related to the realized volatility. The negative relationship is not confined to the group of negative earnings surprises. These results suggest that a dynamic of inverse relationship between returns and volatilities coexists with a risk-return tradeoff around earnings announcements. Extending our study to Asian-Pacific stock market might shed lights on commonalities and differences in international risk-return tradeoff.