Streaks in Earnings Surprises and the Cross-Section of Stock Returns

• Main Authors: LOH, Roger, WARACHKA, Mitch
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2012
• Subjects: Trends; Streaks; Gambler's Fallacy; Post-Earnings Announcement Drift; Finance and Financial Management; Portfolio and Security Analysis
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/3204; https://ink.library.smu.edu.sg/context/lkcsb_research/article/4203/viewcontent/Loh2012mnscStreaksEarningsSurprises_pub.pdf
• Institution: Singapore Management University

The gambler's fallacy (Rabin, 2002) predicts that trends bias investor expectations. Consistent with this prediction, we find that investors underreact to streaks of consecutive earnings surprises with the same sign. When the most recent earnings surprise extends a streak, post-earnings announcement drift is strong and significant. In contrast, the drift is negligible following thetermination of a streak. Indeed, streaks explain about half of the post-earnings announcement drift in our sample. Our results are robust to more general definitions of trends than streaks and a battery of control variables including the magnitude ofearnings surprises and their autocorrelation. Overall, post-earnings announcement drift has a significant time-series component that is consistent with the gambler's fallacy.