The Ex Ante and Ex Post Price Effects of Quarterly Earnings Announcements Reflected in Option and Stock Prices

Abstract

The subject of this study is the effect of investors' anticipations of impending informative disclosures on the behavior of option and stock prices. Our approach, introduced in a previous paper (Patell and Wolfson [1979]) and substantially extended here, represents the following significant departure from traditional information content studies. Instead of analyzing security price reactions to announcements, we analyze preannouncement option prices in order to discern investors' beliefs about the range of possible stock price reactions expected to accompany a forthcoming disclosure whose actual content is not yet known.' In the tests reported here, we focus on quarterly earnings announcements as disclosure events whose timing is predictable, and we attempt to detect their systematic influence on the relationship between stock and option prices. Our operational definition of information content emphasizes changes in the variability of common stock returns in response to earnings disclosures. While market efficiency precludes investors from predicting the direction of the stock price change which will accompany a future earnings announcement, it is likely that investors will anticipate increased price variability at the time of disclosure, and indeed, several studies have documented announcement date increases in stock price volatility.