Post-Earnings Announcement Drift
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Write-Up #1: PEADPost-earnings announcement drift (PEAD) is the tendency that a stock’s cumulative abnormal returns drift in the direction of an unexpected earnings for an extended period of time following an earnings announcement.In this article, Bernard and Thomas (1990), investigated the possibility that PEAD arises because stock prices fail to reflect the implications of current earnings for future earnings. Their hypothesis was that stock prices appear to reflect, at least partially, a naive earnings expectation which based on a seasonal random walk, where expected earnings were simply earnings for the corresponding quarter from the previous year. Then they referred to the prior study of the time-series behavior of quarterly earnings. If an earnings increase over the prior year were announced in quarter t, the market would be surprised to learn that earnings tend to increase again, over the prior year, in quarters t+1, t+2 and t+3, and thus would, on average react positively to the earnings announcements for those quarters, which is due to the view that stock prices initially underreact to quarter t earnings information. Likewise, a portion of the quarter t earnings increase tends to be reversed in t+4 in terms of a prior overreaction. In addition, the article also concluded that several factors such as research design flaws, incomplete controls for risk, and transaction cost could not give satisfactory explanation for the evidence. Therefore, we think the only reason of the phenomenon of PEAD is due to market inefficiency.

The existence of PEAD is considered an anomaly within the efficient markets hypothesis (EMH) developed by Eugene Fama. According to the EMH, the stock market always trades at fair value and current stock prices incorporate all available information. This implies that any new information that is introduced into the market is immediately reflected through changes in stock price. The existence of a PEAD challenges the EMH since it indicates that the new information from earnings announcements is not immediately reflected in prices and that the market under-reacts to the additional information. In Bernard and Thomas (1990), they observed a PEAD extending 13 consecutive years. This suggests that the inefficiencies of the market far exceed a simple, one-time anomaly of under-reaction by investors.       In this inefficient market, one sees that current earnings and financial information has some predictive power about the future earnings of firms. This predictive power is evidenced by the trend noted earlier where the subsequent 3 earnings announcements will continue in the same direction as the current earnings announcement and then be reversed at the 4th subsequent announcement. The existence of this pattern shows under- and over-reaction by the market to earnings announcements and the fact that there is any predictive power in the earnings announcements shows that markets do not fully incorporate new information immediately into stock prices. We also predict that smaller firms would have greater PEAD effects than larger firms, meaning that the market is less likely to incorporate the information into the stock price. This may be due to the perception that smaller firms are riskier than larger corporations and therefore investors are more hesitant about the earnings being indicative of future earnings. Overall, persistent PEAD is an indicator of an inefficient market and highlights the fact that investors do not incorporate all the possible information they can into stock prices whether due to perceived risk, transaction cost, or differences in interpreting information. If there is a market where the PEAD persists over a long period of time, we would expect that behavior of speculation will appear 1 or 2 years after the announcement in an efficient and rational market since investors could predict the trends of company stock prices due to the changes in abnormal return affected by PEAD in previous years. Then, they could establish long positions at t+1 every year when the stock price is going to increase, and establish short positions at t+4 when the stock price is going to reverse. However, this phenomenon may gradually disappear in the future since the more investors who adopt speculation, the less CAR changes are reflected by PEAD.

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Peadpost-Earnings Announcement Drift And Stock Prices. (July 14, 2021). Retrieved from https://www.freeessays.education/peadpost-earnings-announcement-drift-and-stock-prices-essay/