Event-Specific Uncertainty and its Expected Resolution

Abstract

Disclosure models predict stronger responses to new information when investors are more uncertain prior to the announcement of that information, and that returns will be concentrated in periods in which uncertainty is expected to be resolved. Yet empirical tests of these predictions have generated only modest support. We hypothesize that investor response to new information will depend upon the combined effect of uncertainty about the disclosed information and the extent to which that information will resolve uncertainty about firm value; we term the combined effect “event-specific uncertainty”. We examine investor response to earnings announcements, and find that investors respond more strongly when event-specific uncertainty is higher. We then show that a larger proportion of annual returns are realized during earnings announcement periods that are characterized by relatively higher ex ante event-specific uncertainty. Importantly, other measures of uncertainty do not demonstrate these results. Finally, we show that relative ex ante event specific uncertainty varies intuitively with the characteristics of a firm’s information environment.