Abstract
Abstract This study examines the profitability of trading on earnings surprises in the post-earnings announcement period for equities listed in the Shanghai and Shenzhen stock exchanges spanning the period 2000 to 2008 when Chinese markets were developing. The paper also examines whether the drift is a priced risk factor. We show that a post-earnings announcement drift (PEAD) anomaly exists inChina. We document that a hedge strategy of going long on stocks in the highest earnings surprise decile and going short on firms in the lowest earnings surprise decile generates 7.92% excess return in the 60 days following the earnings announcement. We also show that the PEAD is a priced risk factor. Our paper is the first to document that PEAD is systematically priced as a risk factor in stock returns. JEL classification: G11 G14 G15 M41
Highlights
In this paper we examine the profitability of trading on earnings surprises in the post-earnings announcement period for equities listed in the Shanghai and Shenzhen stock exchanges spanning the period 2000 to 2008
Our study is different from that study in several aspects: we include divergence of opinion as a potential factor to explain postearnings announcement drift (PEAD); more importantly, from an asset pricing point of view, we examine whether the PEAD is a priced risk factor in explaining stock returns in the Chinese market, which is a major contribution of our study
market risk (MKTRISK) is the return variance explained by the market model regression: PRICE is the closing stock price 20 days prior to the earnings announcements; VOLUME is the average dollar trading volume from day -120 to day -20 relative to earnings announcements; SIZE is the market capitalization in the one month prior to earnings announcement; B/M is the ratio of the book value of equity to market capitalization; and △TO is a proxy for divergence of opinion as described
Summary
In this paper we examine the profitability of trading on earnings surprises in the post-earnings announcement period for equities listed in the Shanghai and Shenzhen stock exchanges spanning the period 2000 to 2008. Garfinkel and Sokobin (2006) provide a comprehensive study examining the relation between divergence of opinions and PEAD They use unexpected trading volume as a proxy for divergence of opinion and find that unexpected trading volume around earnings announcements are positively related to future returns. Berkman et al (2009) use five proxies for divergence of opinion (earnings volatility, return volatility, dispersion of analysts’ earnings forecasts, firm age, and share turnover) and find that stocks with a high divergence of opinion among investors have a price run-up prior to earnings announcements followed by a greater price reversal after the announcements. We use the closing stock price 20 days prior to earnings announcement (PRICE) and the daily closing price times daily shares traded averaged over -120 to -20 days relative to earnings announcements (VOLUME) as proxies for transaction cost and liquidity. Earnings surprise measures and other potential determinants of post-earnings-announcement abnormal returns
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