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A Multifactor Explanation of Post-Earnings Announcement Drift

Published online by Cambridge University Press:  06 April 2009

Dongcheol Kim  and
Myungsun Kim
Dongcheol Kim
Affiliation:
[email protected], Department of Finance and Economics, Faculty of Management, Rutgers University, New Brunswick, NJ 08903 and College of Economics and Finance, Hanyang University, Seoul, Korea;
Myungsun Kim
Affiliation:
[email protected], School of Accountancy, College of Business, University of Missouri-Columbia, Columbia, MO 65211.
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Abstract

To explain post-earnings announcement drift, we construct a risk factor related to unexpected earnings surprise, and propose a four-factor model by adding this risk factor to Fama and French's (1993), (1995) three-factor model. This earnings surprise risk factor provides a remarkable improvement in explaining post-earnings announcement drift when included in addition to the three factors of Fama and French. After adjusting raw returns for the four risk factors, the cumulative abnormal returns over the 60 trading days subsequent to quarterly earnings announcements are economically and statistically insignificant. Furthermore, except for the first two days after the earnings announcement, the cumulative abnormal returns and the arbitrage returns from our four-factor model are relatively stable over the testing period and never significant on any day of the testing period. On the other hand, the arbitrage returns from the other models increase over the 60-day testing period. We argue that most of the post-earnings announcement drift observed in prior studies may be a result of using misspecified models and failing to appropriately adjust raw returns for risk.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 38 , Issue 2 , June 2003 , pp. 383 - 398
Copyright
Copyright © School of Business Administration, University of Washington 2003

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