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Post Loss/Profit Announcement Drift

Last Updated on 10 February, 2024 by Rejaul Karim

In the examination of market dynamics, Karthik Balakrishnan, Eli Bartov, and Lucile Faurel present the research titled “Post Loss/Profit Announcement Drift” in the Journal of Accounting & Economics.

The study uncovers a market failure to promptly respond to loss/profit quarterly announcements, revealing an annualized post-portfolio formation return spread of approximately 21 percent between extreme losses and extreme profits. This anomaly persists independently of various risk adjustments, including distress risk, firm size, and transaction costs.

Notably, the mispricing is connected to differences between conditional and unconditional probabilities of losses/profits, indicating that stock prices may not promptly reflect conditional probabilities. This research sheds light on a previously undocumented anomaly, contributing valuable insights into the nuanced behavior of markets following loss/profit announcements.

Abstract Of Paper

We document a market failure to fully respond to loss/profit quarterly announcements. The annualized post portfolio formation return spread between two portfolios formed on extreme losses and extreme profits is approximately 21 percent. This loss/profit anomaly is incremental to previously documented accounting-related anomalies, and is robust to alternative risk adjustments, distress risk, firm size, short sales constraints, transaction costs, and sample periods. In an effort to explain this finding, we show that this mispricing is related to differences between conditional and unconditional probabilities of losses/profits, as if stock prices do not fully reflect conditional probabilities in a timely fashion.

Original paper – Download PDF

Here you can download the PDF and original paper of Post Loss/Profit Announcement Drift.

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Author

Karthik Balakrishnan
Rice University – Jesse H. Jones Graduate School of Business

Eli Bartov
NYU Stern School of Business

Lucile Faurel
Arizona State University

Conclusion

In summation, the investigation into post-loss/profit announcement drift, as delineated in the Journal of Accounting & Economics, underscores a persistent market inefficiency in fully incorporating quarterly announcements of losses and profits.

This anomaly is distinctly characterized by an annualized post-portfolio formation return spread of approximately 21 percent between portfolios built on extreme losses and extreme profits. Significantly, this mispricing remains robust across various risk adjustments, firm-specific factors, and alternative periods, marking it as an incremental and resilient phenomenon in the landscape of accounting-related anomalies.

The study illuminates the intricate relationship between mispricing and the divergence between conditional and unconditional probabilities of losses/profits, hinting at a delay in the market’s assimilation of conditional probabilities. This conclusive evidence contributes valuable insights to our understanding of market behaviors surrounding earnings announcements.

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FAQ

– What does the Journal of Accounting & Economics reveal about the profit announcement drift, and what distinguishes it as a market inefficiency?

The Journal of Accounting & Economics sheds light on the profit announcement drift, emphasizing it as a persistent market inefficiency. Specifically, the anomaly is characterized by an annualized post-portfolio formation return spread of around 21 percent between extreme losses and extreme profits. This distinction underscores the market’s failure to fully incorporate quarterly announcements of losses and profits, marking it as a noteworthy inefficiency in the financial landscape.

– How does the mispricing associated with profit announcement drift withstand various risk adjustments, firm-specific factors, and alternative periods?

The mispricing linked to profit announcement drift is demonstrated to be robust across a spectrum of factors. The study highlights that this market inefficiency persists even after applying risk adjustments, considering firm-specific factors, and examining alternative periods. The resilience of the mispricing across these dimensions further solidifies it as an incremental and enduring phenomenon within the realm of accounting-related anomalies.

– What insights does the study provide regarding the intricate relationship between mispricing and the conditional and unconditional probabilities of losses/profits during earnings announcements?

The study delves into the intricate relationship between mispricing and the divergence between conditional and unconditional probabilities of losses and profits during earnings announcements. The findings suggest a delay in the market’s assimilation of conditional probabilities, contributing valuable insights into market behaviors surrounding earnings announcements. This conclusive evidence enhances our understanding of the dynamics at play during profit announcement drift, offering a nuanced perspective on how market participants process and react to information related to earnings.

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