Abstract
We test the proposition in Johnstone (2016) that new information may lead to higher, rather than lower, uncertainty about firms’ future payoffs. Based on the Bayesian rule, we hypothesize earnings news that is inconsistent with investors’ prior belief will lead to higher market uncertainty. Using earnings signals in the past eight quarters to proxy for investors’ prior belief, we find supporting evidence that, relative to consistent earnings news, inconsistent news increases market uncertainty measured by implied volatility. Inconsistent earnings news has a larger effect on market uncertainty when prior beliefs are stronger, when the news is negative, and when firms have a better information environment. Overall, our evidence highlights the importance of prior belief and inconsistent signals in understanding the effect of earnings news on market uncertainty.
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