Return Drift Research Articles

Initial Evidence on the Market Impact of the iXBRL Adoption

SYNOPSISIn June 2018, the SEC adopted Inline eXtensible Business Reporting Language (iXBRL), which embeds XBRL data into HTML-formatted annual reports to improve the accessibility and usefulness of the information disclosures to investors. This study assesses the effectiveness of iXBRL by examining its impact on informational efficiency and information asymmetry. Using a sample that includes iXBRL voluntary adopters before 2019, we find that iXBRL adoption lowers stock return drift and facilitates information being impounded into firm stock prices following the filing of annual reports. We also find that unlike XBRL, iXBRL reduces information asymmetry in the long run. These findings are consistent with the SEC’s intention of adopting iXBRL to combine human-readable and machine-readable information. Our study provides initial evidence on the effectiveness of iXBRL in communicating information to the external users of annual reports.

Can the Market Multiply and Divide? Non‐Proportional Thinking in Financial Markets

ABSTRACTWe hypothesize that investors partially think about stock price changes in dollar rather than percentage units, leading to more extreme return responses to news for lower‐priced stocks. Consistent with such non‐proportional thinking, we find a doubling in price is associated with a 20% to 30% decline in volatility and beta (controlling for size/liquidity). To identify a causal price effect, we show that volatility jumps following stock splits and drops following reverse splits. Lower‐priced stocks also respond more strongly to firm‐specific news. Non‐proportional thinking helps explain asset pricing patterns such as the size‐volatility/beta relation, the leverage effect puzzle, and return drift and reversals.

Pervasive underreaction: Evidence from high-frequency data

We propose a novel high-frequency decomposition of daily stock returns into news- and non-news-driven components, and uncover evidence of pervasive stock market underreaction to firm news. Prices tend to drift in the same direction as the initial market response for several days after the news arrival without reversals. A trading strategy exploiting the return drift generates high abnormal returns and remains profitable after transaction costs. To understand the economic mechanism, we find that the return drift is stronger when investors are distracted. Analysts’ slow adjustments of market expectations following firm news also contribute to the market underreaction.

Effect of coronavirus fear on the performance of Australian stock returns: Evidence from an event study

Using an event study methodology and a sample of 478 firms listed on the Australian Securities Exchange, we find the following results. First, coronavirus fear significantly and adversely affected the returns of many sectors, small-, medium- and large-sized stocks. Second, coronavirus fear was a source of return drift in the Australian stock market. Our results suggest that investors underreacted to coronavirus fear, and this underreaction was prevalent across a range of sectors and firm size categories. We also find that had investors adopted a short selling strategy for stocks that suffered significant negative effects from the coronavirus fear and post-event return drift, they would have gained profits ranging from 2.14% to 13.81%. Robustness tests based on longer event windows confirm the main results. Additionally, we find evidence of reversals in stock returns mostly following the first stimulus payment in Australia. However, large firms and the information technology sector were the first to experience a reversal in returns a few days following the announcement of the second stimulus package and the commencement of lockdown but before the first stimulus payment was made.

SPACs and Forward-Looking Disclosure: Hype or Information?

Regulators and legal scholars express concern that SPAC growth results from a disclosure-regulation loophole and that forward-looking disclosure by SPACs can mislead investors. We examine SPAC voluntary disclosure and associated outcomes. SPACs offer a means for firms to become public, but, unlike IPOs, we find SPAC firms frequently provide forward-looking information (e.g., earnings forecasts). Measuring disclosure by tone, the existence of a forecast, forecasting intensity, and forecast growth rates, our results suggest that forward-looking disclosure in SPAC merger announcements does not mislead small investors. Disclosures containing more forecasts are associated with positive returns at the announcement. However, our disclosure measures are not associated with subsequent return reversals. More forecasts are related to positive subsequent return drift, lower redemption rates and bid-ask spreads, and more retail investor buying. We do not find evidence that forecasted sales or EBITDA growth rates are associated with return reversals. In fact, we find a positive relation between forecasted sales growth and returns around the first post-closing earnings announcement. Moreover, correlations between outcomes and disclosure tone are not significant, suggesting that hype, if present, does not sway investors. Our findings do not support the concern that SPACs take advantage of apparent exemption from prosecution under the 1933 Act to hype forward-looking disclosure to deceive shareholders.

Are Critical Audit Matters Informative?

Breaking from a long stretch of using largely standard language in unqualified audit opinions, the Public Company Accounting Oversight Board (PCAOB) expanded audit reports to disclose Critical Audit Matters (CAMs) and the audit procedures used to address them. The first wave of CAM disclosures began for large accelerated filers after June 2019, with most disclosures occurring in February 2020. Using Natural Language Processing (NLP) techniques, this study examines the types of CAMs disclosed by auditors and the typical audit procedures used to address them. We then explore whether CAMs are informative to investors and security analysts. Our findings are consistent with greater amounts of CAM disclosures as indicators of greater uncertainty. We document that market reactions are more negative for firms with more CAM disclosures; analysts reduce their earnings forecasts to a larger extent for such firms; stock prices become more volatile; and the dispersion of analyst forecasts are greater for firms with more CAM disclosures. We further find that many issues related to CAMs are raised in earnings conference calls with analysts during the immediately subsequent quarter. While these findings indicate that CAMs are informative to investors and analysts, their effects are concentrated around the time of disclosure. We do not find evidence of a drift in returns after the initial disclosures.

Valuation Ratios, Surprises, Uncertainty or Sentiment: How Does Financial Machine Learning Predict Returns From Earnings Announcements?

We apply state-of-the-art financial machine learning to assess the return-predictive value of more than 45,000 earnings announcements on a majority of S&P1500 constituents. To represent the diverse information content of earnings announcements, we generate predictor variables based on various sources such as analyst forecasts, earnings press releases and analyst conference call transcripts. We sort announcements into decile portfolios based on the model’s abnormal return prediction. In comparison to three benchmark models, we find that random forests yield superior abnormal returns which tend to increase with the forecast horizon for up to 60 days after the announcement. We subject the model’s learning and out-of-sample performance to further analysis. First, we find larger abnormal returns for small-cap stocks and a delayed return drift for growth stocks. Second, while revenue and earnings surprises are the main predictors for the contemporary reaction, we find that a larger range of variables, mostly fundamental ratios and forecast errors, is used to predict post-announcement returns. Third, we analyze variable contributions and find the model to recover non-linear patterns of common capital markets effects such as the value premium. Leveraging the model’s predictions in a zero-investment trading strategy yields annualized returns of 11.63 percent at a Sharpe ratio of 1.39 after transaction costs.

Stock Specific Negative Return Drift in Optimized Portfolios

Most Quant PMs have observed that while their alpha strategy delivers good returns, performance attribution have an unexpected behavior. It shows that while they are making money on Common Factor bets, they are systematically losing money on stock specific bets. The negative stock specific drift can be very significant. Understanding the causes of such negative contribution leads to significant performance improvement.

Cash Flow Restatements: Stock Market Reaction to Overstated versus Understated Restatements

The Securities and Exchange Commission has become increasingly concerned with the rising number of restatements to statements of cash flows (SCFs). Regulators and practitioners are generally more focused on the overstatement of operating cash flows, while the understatement of operating cash flows is often overlooked but may have the same (or more) negative economic consequences. We examine market reactions to cash flow restatements (CFRs) where firms overstate or understate cash flows from 2000 to 2013. This study finds that 41% of firms overstated operating cash flows, while a surprising 48% understated operating cash flows. While we find that the market does not react to overstated operating cash flows or overstated total cash flows (TCFs), we find a negative response to understated operating cash flows and understated TCFs. Interestingly, the market penalizes these firms more for understating rather than overstating cash flows. There is a CFR disclosure post-announcement drift in abnormal returns that occurs for both understated operating and understated TCFs. We provide evidence that the often-overlooked understated CFRs may have “real” economic consequences and that they should be evaluated further and given the same consideration as overstatements by auditors, regulators, and investors.

Analysts’ Earnings Forecast, Recommendation and Target Price Revisions

This study examines the immediate and delayed market responses to revisions in analyst forecasts of earnings, target prices, and recommendations. Consistent with prior literature, revisions in earnings forecasts are positively and significantly associated with short-term market returns around the revisions. However, we show that short-term market returns around target price revisions and recommendation changes are even stronger. We also find superior future performance (return drift) for portfolios that use information from all three types of revisions to those using information from only one of the three types of revisions.

Is Extended-Hours Trading Indicative of Subsequent Returns?

Trading outside the main session occurs between 4:00 p.m. and 8:00 p.m. and between 4:00 a.m. and 9:30 a.m. It is typically dominated by institutional investors. This study examines whether trading in the extended hours is predictive of future returns. The article shows that when significant new earnings information is released during the extended-hours sessions, the extended-hours returns are positively and significantly associated with the following main session returns and even with long-term drift returns. The signal based on the extended-hours return is incrementally beneficial in predicting the future returns beyond the earnings surprise signal. The evidence is consistent with an underreaction to information on earnings news days and suggests that the return reaction during extended trading hours can help predict the return drift after earnings disclosure.

New Evidence of Psychological Barrier from the Oil Market

ABSTRACTThe authors examine how stock returns were affected when the oil price reached the psychological barrier of US$100 per barrel for the first time in history. Using an event study approach, 4 key results emerge. First, the authors show that a psychological barrier event in the oil market does affect stock returns. Second, they show that a psychological barrier event in the oil market is a source of return drift—a phenomenon well explained and understood with respect to nonoil news events. Third, the psychological barrier affects small/medium-sized stocks and not large stocks. Last, the authors show that successful trading strategies can be devised based on the information that the oil price psychological barrier significantly impacts the market and that it contributes to return drift.

Downward Nominal Price Rigidity and Earnings Persistence

Does nominal price rigidity spread to equity markets? I use a fuzzy regression discontinuity design to show that company operating income is less persistent when input prices decrease than when input prices increase by the same size. This asymmetry arises because nominal prices for outputs are downwardly rigid. Analysts incorporate this asymmetric effect on income persistence in their forecasts with a delay. Firms that receive downward (upward) shocks to input costs experience negative (positive) return drift following earnings announcements. The findings suggest that, through the channel of price rigidity, small nominal shocks can have a large impact on stock prices.

Sentiment and Stock Returns

This study documents the effect of the Super Bowl on the stock returns of firms that are geographically associated with the competing teams. We find significant upward return drift in the 9 trading days leading up to the Super Bowl, a pattern consistent with investors trading in anticipation of the game itself. The “anticipatory behavior” among investors leads to widespread pregame returns, which is not documented in prior studies. These pre-event abnormal returns are positive and statistically and economically significant for all firms, and the size of pre-event returns varies according to each team’s favored status. In addition, firms associated with the winning team exhibit significant positive return drift over the 10-day period after their win. Firms associated with the losing team exhibit moderate downward drift. Our findings are strongest among the smallest quintile of firms and are robust to various risk adjustments and using a matched sample control group. The collective findings suggest that only by standing on the sideline will investors avoid winning around the Super Bowl.

Dividend initiations, increases and idiosyncratic volatility

We examine three aspects of the relation between dividend initiation and increase announcements and idiosyncratic volatility. First, consistent with dividend signaling, we find that firms with higher levels of idiosyncratic volatility are associated with higher announcement abnormal returns when initiating or increasing dividends. Second, firms on average experience an ex post reduction in idiosyncratic volatility following dividend initiations that is associated with announcement and long-term abnormal returns. Finally, high idiosyncratic volatility firms are associated with stronger positive post event return drift.

Are Extended Hours Prices Predictive of Subsequent Stock Returns?

Trading outside the main session occurs between 4:00PM-8:00PM and 4:00AM-9:30AM and is typically dominated by institutional investors, as retail investors are discouraged to trade in the extended trading hours. This study examines whether trading in the extended hours is predictive of future returns. It shows that on regular trading days, extended hours returns are negatively associated with returns in the Main trading session (9:30AM-4:00PM), consistent with extended hours trading that is induced by liquidity needs rather than information. In contrast, when significant new information is released during the extended hours sessions such as earnings, analyst recommendation changes, and SEC filings, the extended hours returns are positively and significantly associated with the following Main session returns, and even with long-term drift returns. The evidence is consistent with an under-reaction to information on news days, and suggests that the return reaction during extended trading hours can help predict the return drift after news events.

Influence of rough and smooth walls on macroscale granular segregation patterns.

Size bidisperse granular materials in a spherical tumbler segregate into two different patterns of three bands with either small particles at the equator and large particles at the poles or vice versa, depending upon the fill level in the tumbler. Here we use discrete element method simulations with supporting qualitative experiments to explore the effect of the tumbler wall roughness on the segregation pattern, modeling the tumbler walls as either a closely packed monolayer of fixed particles resulting in a rough wall or a frictional geometrically smooth wall. Even though the tumbler wall is in contact with the flowing layer only at its periphery, the impact of wall roughness is profound. Smooth walls tend toward a small-large-small (SLS) band pattern at the pole-equator-pole at all but the highest fill fractions; rough walls tend toward a large-small-large (LSL) band pattern at all but the lowest fill fractions. This comes about because smooth walls induce poleward axial drift of small particles and an equator-directed drift for large particles, resulting in an SLS band pattern. On the other hand, rough walls result in both sizes of particles moving poleward at the surface of the flow. Due to radial segregation, small particles percolate lower in the flowing layer and when arriving near the pole are caught in the return current drift that carries them back toward the equator incrementally with each passage through the flowing layer, while large particles remain at the surface near the pole, resulting in an LSL band pattern. The tendency toward either of the two segregation patterns depends on the fill level in the tumbler and the roughness of the tumbler's bounding wall.

News Momentum

We propose a novel high-frequency decomposition of daily stock returns into news- and non-news-driven components, and uncover evidence of pervasive stock market underreaction to firm news. Prices tend to drift in the same direction as the initial market response for several days after the news arrival without reversals. A trading strategy exploiting the return drift generates high abnormal returns and remains profitable after transaction costs. To understand the economic mechanism, we find that the return drift is stronger when investors are distracted. Analysts' slow adjustments of market expectations following firm news also contribute to the market underreaction.

Can analysts pick stocks for the long-run?

This paper examines post-revision return drift, or PRD, following analysts’ revisions of their stock recommendations. PRD refers to the finding that the analysts’ recommendation changes predict future long-term returns in the same direction as the change (i.e., upgrades are followed by positive returns, and downgrades are followed by negative returns). During the high-frequency algorithmic trading period of 2003–2010, average PRD is no longer significantly different from zero. The new findings agree with improved market efficiency after declines in real trading cost inefficiencies. They are consistent with a reduced information production role for analysts in the supercomputer era.

The information content of R&D reductions

An extensive literature shows that R&D intensities and increases are positively related to firm performance, but little research examines the valuation of R&D reductions. This paper fills the void by studying long-term performance following R&D reductions. We find that, contrary to conventional wisdom, large R&D cuts are associated with positive future stock returns. This return drift cannot be explained by asset pricing factors, including R&D intensities and R&D increases. We explore two potential economic motives behind R&D reductions: R&D spillover and firm life cycle. We show that operating performance deteriorates immediately before R&D reductions but exhibits no abnormal pattern afterward. While firm growth falls substantially and variability in profitability reduces, firms with low or declining investment opportunities and mature firms outperform. These findings are inconsistent with the spillover hypothesis, but support the life cycle story that firms attempt to resolve overinvestment in R&D that arises over the course of firm life cycle.