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How Would You Characterize a Market in Which the Pead Exists for Many Consecutive Years?

Autor:   •  November 14, 2017  •  Essay  •  504 Words (3 Pages)  •  680 Views

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How would you characterize a market in which the PEAD exists for many consecutive years?

The PEAD, or the post-earnings announcement drift, is the behavior of a stock’s cumulative abnormal returns to follow the direction of an earnings surprise (or the difference between actual earnings and expected earnings) for a period that lasts anywhere from weeks to months after an earnings announcement. However, as noted in Bernard and Thomas (1990), this drift does not occur all at once; instead, it is divided up amongst subsequent quarters following the announcement. More specifically, Bernard and Thomas find that the proportion of the drift associated with good news (bad news) of an announcement at quarter t will be positive (negative) and higher in the quarter t+1. The proportion of the drift will diminish with each additional quarter but then reverse in the quarter t+4 to be negative (positive) and be proportionately high. For example, using the results in Table 1 from Bernard and Thomas (1990), in quarters t+1, t+2, t+3, and t+4, the proportion of the abnormal returns in quarter t are distributed as 34%, 19%, 6%, and -24%, respectively.

To characterize a market in which the PEAD exists for many consecutive periods, one must consider what this phenomenon indicates. Under this phenomenon, an investor cannot forecast a stock price using all relevant information based on a standard expectation for current earnings from the corresponding previous quarter and corresponding future quarter earnings from the current earnings because of the diminishing drift. The diminishing drift occurs because of the market’s underreaction (or late reaction) to the information from the earnings announcement of quarter t as illustrated by the fact that a significant proportion of the abnormal return from quarter t does not occur in quarter t, but rather in subsequent quarters. Regarding the efficient market theory, because the market does not adequately react to the relevant public information in the respective quarter, the market cannot be categorized as semi-strong. Instead, the authors propose that the market is weak. Meaning, as Bernard and Thomas (1990) suggest in the title of their article, “stock prices do not fully reflect the implications of current earnings for future earnings.”

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