Clever tests to discriminate between alternative explanations. LaPorta, Lakonishok, Shleifer, and Vishny ("Good News for Value Stocks," Journal of Finance, June 1997) study the returns on stocks on the few days surrounding their quarterly earnings announcements (relative to various expected return benchmarks). They ﬁnd that on average, high-B/M stocks earn 0.9% around an earnings announcement. In contrast, low-B/M stocks earn an average of - 0.1% around an earnings announcement. The diﬀerence is statistically signiﬁcant.

Discuss whether the return pattern found by LaPorta et al. (1997) around earnings announcements is more consistent with the irrational expectations (behavioral) view, or the risk factor (efficient markets) view of the book-to-market effect, and explain your logic.

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Aarav

Business

30 September, 03:03

Clever tests to discriminate between alternative explanations. LaPorta, Lakonishok, Shleifer, and Vishny ("Good News for Value Stocks," Journal of Finance, June 1997) study the returns on stocks on the few days surrounding their quarterly earnings announcements (relative to various expected return benchmarks). They ﬁnd that on average, high-B/M stocks earn 0.9% around an earnings announcement. In contrast, low-B/M stocks earn an average of - 0.1% around an earnings announcement. The diﬀerence is statistically signiﬁcant.

Discuss whether the return pattern found by LaPorta et al. (1997) around earnings announcements is more consistent with the irrational expectations (behavioral) view, or the risk factor (efficient markets) view of the book-to-market effect, and explain your logic.

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Darian Roach · Answer 1

The answer to the above question is:

"The return patterns around earnings announcement is an example of behaviorial pattern exhibiting as more investors flock to buy the stock which has shown better earnings thus driving up the price. In an efficient market, this information would already be built into the price and thus there would not be any appreciable change in price post earning announcement".