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1
Explanations:
CAPM price, which means that CAPM cannot be how the market
knows of the drift, yet does not take the drift into account in
2
also explains (1) why the size of the drift varies by size of
the company, (2) that the market is not efficient, (3) why stock
prices tend to rise after a stock split, and (4) some of the
3
I. INTRODUCTION
confirmed that PEAD does exist, but has not explained why PEAD
This work has already been exposed for comment and review.
well trained in the future may well have had this method of
4
analysis incorporated into their training. Accordingly,
Appendix.
the market, such is not the case with respect to the abnormal
5
Liu, Strong, and Xu (2003, 90) said that "Fama (1998) refers to
drift, or PAD
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surprise portfolios. Sixth, no satisfactory explanation for the
studies."
results are consistent with the results in Part IV, but they
important.
Securities Markets
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practitioners have devoted a great deal of effort to the theory
not correct.
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8
! If the market is efficient with respect to public
announcements, stock price changes associated with that
information would be contemporaneous with the public
announcement of the earnings. While there would be a price
adjustment at the time of announcement, abnormal returns
would not be observed after the announcement (Watts 1978,
129).
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adjustments that occur at those dates (320) (Bernard and
Thomas 1990, 305-306 and 320).
10
The Capital Asset Pricing Model (CAPM)
1979, 169) is
COV( R j , R m )
E( R j ) = R f + [E( R m ) - R f ]
VAR( R m )
plus [(the expected market rate less the risk-free rate) times
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The Efficient Market Hypothesis (EMH)
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The Effect of Combining the Capital Asset Pricing Model and the
Efficient Market Hypothesis
price, and everybody knows the correct price. Any movement away
CAPM price, and no seller would accept less than the publicly
small cases.
13
Post-Earnings-Announcement Drift Is Incompatible with the
Capital Asset Pricing Model (CAPM)
even without regard to whether the EMH is true, the drift tells
securities.
research.
14
! One argument supported by the EMH contends that if any
systematic method of obtaining abnormal excess returns
exists and if that method becomes known to the public, then
the mechanics of an efficient market will negate the
realization of any further benefits derived from the use of
that method (Bidwell and Riddle 1981, 211).
announcement drift
15
! Hew, Skerratt, Strong, and Walker (1996, 283) stated:
16
which is a violation of the (semi-strong) efficient market
hypothesis (Kim and Kim 2003, 383).
17
values do not accurately reflect fundamentals (600). ...
The evident difficulty economists have in explaining any
significant amount of the variations in speculative prices
on the basis of "news" about fundamentals also suggests
that valuation errors are being made continuously (600)
(Summers 1986, 591-592).
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authors’ findings. It is quite similar to Bernard (1993, 319),
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which was on the right track was Bernard and Thomas (1990, 306):
19
that a firm announces positive (negative) unexpected
earnings for quarter t, the market tends to be positively
(negatively) surprised in the days surrounding the
announcement for quarter t + 1.
capital market prices an asset, and when they found PEAD, they
did not start from the beginning; they assumed that CAPM is
20
securities according to CAPM) rather than a fact, then their
work which showed a market-price drift from the CAPM price would
have led them to conclude that the market does not price
market price differs from the correct price per CAPM, they would
have said that CAPM does not accurately model the correct market
price.
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165 and 167, used data from 1946 to 1966.) Take any Point A
that this is the starting point of a study which finds PEAD, and
21
Thus, at any intermediate Point B, and at any final Point C,
because of PEAD, we know that the CAPM price is not the correct
22
! A perfect capital market is a key assumption in recent
theories of security pricing.2 It is assumed that the costs
of transactions, information-gathering, and portfolio
management are all zero.... (Mao 1971, 1105)
23
brokers want to earn more money rather than less, they have an
that all those who wanted to sell have sold, and as much as they
conclude that all those who wanted to buy have bought as much as
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business curriculum, this market price is set by the
Figure 3.
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shown in Figure 4.
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2. Let us show only the three points J, K, and L, as
shown in Figure 5.
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Figure 7.
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determined.
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27
one shift of the demand curve plus at least one shift of the
one shift of the supply curve plus at least one shift of the
demand curve. Next I will explain why there are shifts in both
28
Departing from its no-frills roots, the San Francisco firm
late this year plans to launch what amounts to a fast-food
version of money management....
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about field studies, "external validity and the practical
over who buys or sells what, nor at what price. Brokers are
in which they do not get paid unless they get clients, and those
client.
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firms large, medium, and small. Some of the brokers had been so
they have been asked to train other brokers, actually know how
explain why PEAD occurs, this article uses the behavior of real
humans who are experts at how the market really works to explain
why at least some things happened the way they did, without
31
What Securities Brokers (i.e., Experts in Market Microstructure)
and Published Sources Told Me About Why Market Transactions
Occur
Not all clients buy right away the stock being pushed by
the broker. Sometimes the broker must get back with them,
predictability.3
32
! “What is a broker? He’s a salesman.” (Wynter, quoting a
brokerage firm founder who recruits securities brokers,
1998, B1)
33
company has announced its earnings. After all, as brokers
pointed out to me, why should customers believe the story when,
earnings which are down from what you said they would be? The
during the period of the early PEAD studies, not even the
of something stale.
know the story and how their customers are likely to react; they
new analyst’s report. But by pushing the stock, the brokers are
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causing an outward shift in the demand curve for that particular
Not all customers want to buy the stock right away. Some
want to “wait and see” what happens to the stock and its price.
else to a customer who will not buy what is being pitched today,
because (a) the broker will just confuse the customer, and (b)
if the customer did not buy the first stock, he is not likely to
buy the second stock. Consequently, the broker makes some note
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to contact the customer again around the time the company is
see that the reported earnings were what the broker told them to
period before they buy, so they can be sure that the earnings
smoothed earnings.
some customers who will buy, some who want to wait and see what
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the announced earnings are and then buy, some who either cannot
be reached or who are out of town for a short time, and some who
every security, but only those customers who the broker thinks
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broker might attempt to sell it to other customers with whom he
mentioned it to them.
V. HYPOTHESES TESTS
The Hypotheses
that all this was just a story, with no theory and no hypothesis
both that (1) if A, then B, and also (2) if not A, then not B.
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This first hypothesis is expected to be impossible to
If A, then B
39
This hypothesis number three is related to the fact that
transactions.
Bernard and Thomas (1989 and 1990) and Ball and Bartov
(1996) used the same data set. Ball and Bartov (1996, 325)
Bernard and Thomas.” Therefore, the evidence all comes from the
earnings are positive in the first quarter for drift firms, and
remain positive until quarter four. Ball and Bartov (1996, 326)
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quarterly earnings information are negative during the three-day
are announced. Ball and Bartov (1996, 327, Table 2) also report
supported.
previously published works which all used the same data set,
smaller the firm size, the larger the absolute magnitude of CARj
41
stated, "we replicate those results and demonstrate that they
stock. Brokers push the demand curve out more for a small firm
with low volume than for a big firm with high volume. More than
customers of the analyst’s firm get the news first. Then word
gets out to the retail brokers, who in turn call their own best
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Consider this real-life example. I was working in South
Carolina one day when I heard from a reliable source that not a
crying for weeks for someone to come pick up a load, but had not
busy with bigger shippers. Now, even those single loads had
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quarter t had already been announced in quarter (t + 1). Then,
to get the customer to sell the security and then use that money
to buy something else. This pitch that the customer should sell
44
Stock Splits à la Fama, Fisher, Jensen, and Roll (1969)
price increase in the United States market, and Ball, Brown, and
45
Because unknowledgeable investors do not understand stock
pay some price (say, sixty dollars per share), but now they can
buy the same number of shares in the same company for less
sixty dollars because the investor has less total money at risk
46
REFERENCES
47
Ball, R. 1992. The earnings-price anomaly. Journal of
Accounting and Economics 15:2/3 (June/September): 319-345.
48
Beaver, W. H. 1968. Information content of annual earnings
announcements. Empirical Research in Accounting: Selected
Studies, 1968, Supplement to Journal of Accounting
Research, 67-92.
49
Bhushan, R. 1994. An informational efficiency perspective on
the post-earnings announcement drift. Journal of
Accounting and Economics 18 (July): 45-65.
50
Brown, S. L. 1978. Earnings changes, stock prices, and market
efficiency. The Journal of Finance 33:1 (March): 17-28.
51
Easton, P. D. and M. E. Zmijewski. 1989. Cross-sectional
variation in the stock market response to accounting
earnings announcements. Journal of Accounting and
Economics 11:2/3 (July): 117-141.
52
Freeman, R. and S. Tse. 1989. The multiperiod information
content of accounting earnings: confirmations and
contradictions of previous earnings reports. Journal of
Accounting Research 27 (Supplement): 49-79.
53
Jensen, M. C. et al. 1978. Symposium on some anomalous
evidence regarding market efficiency. Journal of Financial
Economics 6 (June/September): 93-330. Cited in Summers,
L. H. 1986. Does the stock market rationally reflect
fundamental values? The Journal of Finance 61:3 (July):
591-601.
54
Latané, H. A. and C. P. Jones. 1979. Standardized unexpected
earnings--1971-77. The Journal of Finance 34:3 (June):
717-724.
55
Marais, M. L. 1989. Discussion of Post-earnings-announcement
drift: delayed price response or risk premium? Journal of
Accounting Research 27 (Supplement): 37-48.
56
Riahi-Belkaoui, A. 2002. Level of multinationality as an
explanation for post-announcement drift. The International
Journal of Accounting 37: 413-419.
57
Watts, R. L. 1978. Systematic "abnormal" returns after
quarterly earnings announcements. Journal of Financial
Economics 6 (June-September): 127-150.
58
Appendix
important.
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! The apparent predictability of abnormal returns after
earnings announcements has become one of the most
significant anomalies in financial markets research, for
several reasons. First, the magnitude is daunting; for
example, the estimated abnormal return from trading on
"old" earnings information exceeds the normal return on the
market. Second, the anomaly is ubiquitous; earnings
announcements occur every quarter for every stock. Third,
the anomaly is scientifically indisputable; it appeared in
Ball and Brown (1968) and has been replicated, consistently
and with increasing precision, in one of the most carefully
and thoroughly researched areas of the empirical financial
economics literature. Fourth, taken at face value the
anomaly implies that share markets, which are central to
the economy and which one would think are paradigm examples
of the competitive model, grossly fail the test of
competitive economic theory. Fifth, the anomaly challenges
the theory underlying most of the widely-used models in
modern financial economics (Ball 1992, 319).
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challenges to the EMH (see Ball, 1992 and Lev and Ohlson,
1982). (Hew, Skerratt, Strong, and Walker 1996, 283).
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appears that gaining an understanding of the cause of the
phenomenon is worthwhile.
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Table 1
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Jones, Rendleman, and Latané (1984)
Easton (1985)
Jones, Rendleman, and Latané (1985)
Rosenberg, Reid, and Lanstein (1985)
Kormendi and Lipe (1987)
Rendleman, Jones, and Latané (1987)
Chari, Jagannathan, and Ofer (1988)
Bernard and Thomas (1989)
Easton and Zmijewski (1989)
Freeman and Tse (1989)
Lev (1989)
Bernard and Thomas (1990)
Abarbanell and Bernard (1992)
Affleck-Graves and Mendenhall (1992)
Ball (1992)
Bartov (1992)
Ball, Kothari, and Watts (1993)
Bhushan (1994)
Booth, Kallunki, and Martikainen (1996)
Hew, Skerratt, Strong, and Walker (1996)
van Huffel, Joos, and Ooghe (1996)
Bernard, Thomas, and Wahlen (1997)
Brown (1997)
Calegari and Fargher (1997)
Soffer and Lys (1999)
Mendenhall (2002)
Riahi-Belkaoui (2002)
Asthana (2003)
Liu, Strong, and Xu (2003)
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Table 2
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Figure 1
A Pictorial Representation of Post-Earnings-
Announcement Drift
Price
relative
to the
market
t=0 t=1
Time
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Figure 2
Pictorial Proof that the CAPM Price is Wrong
Price
Relative
to the
Market
67
Figure 3
A Model That Works
Price
S
Market
Price
Quantity
68
Figure 4
Selection of Points Which Lie on the Post-Earnings-
Announcement Drift
Price
relative
to the
market
L
K
J
t=0 t=1
Time
69
Figure 5
Isolation of Points Selected in Figure 4
Price
relative
to the
market
L
K
J
t=0 t=1
Time
70
Figure 6
Undoing Transformation of Points in Figure 5
Price
L
K
J
t=0 t=1
Quantity
71
Figure 7
Price Determination of First Point on PEAD
Price
S0
L
K
J
D0
t=0 t=1
Quantity
72
Figure 8
Price Determination of Second Point on PEAD
Price
S0
L
K
J
D1
D0
t=0 t=1
Quantity
73
Figure 9
Price Determination of Third Point on PEAD
Price
S0
S1
L
K
D2
J
D1
D0
t=0 t=1
Quantity
74