Abstract
The magnitude and direction of earnings surprises are related to changes in liquidity arising from changes in adverse selection. Shares of firms with extreme earnings surprises experience larger increases in adverse selection than shares of firms with moderate earnings surprises in the short interval during the earnings announcements, suggesting that the extremeness of earnings surprises creates uncertainties that increase adverse selection. These changes in adverse selection are highly transitory. In the longer term, adverse selection decreases (increases) for firms with positive (negative) earnings surprises, consistent with the expected changes in the economic and information environment of firms with different earnings surprises.
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