Abstract
In this paper, we generalize Bernard and Thomas' (1990) delayed response hypothesis as an explanation of post-earnings-announcement drifts. By applying a modified version of Beveridge and Nelson’s technique of decomposing a time-series process of earnings into permanent and temporary components, we estimate the relative weight to proxy for investor perception on the temporary component of earnings. We then provide evidence that our measure of investor misperception explains post-announcement drifts after controlling for firm size and investor sophistication. These findings reinforce Bernard and Thomas' (1990) conjecture that less weight is placed on temporary components of earnings than would be appropriate if earnings processes were well understood, though not zero as Bernard and Thomas implicitly assumed in their portfolio formation rule. Our results also complement Ball and Bartov's (1996) result that investors partially, but not fully, adjust for serial correlation in seasonal differences.
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