Price Response to Earnings News: The Effects of Past and Current Market States

• DOI: http://doi.org/10.1002/jcaf.22343
• Published date: 01 July 2018
• Date: 01 July 2018

Price Response to Earnings

News: The Effects of Past

and Current Market States*

Ebenezer Asem and Vishaal Baulkaran

INTRODUCTION

Prior evidence

suggests that the

price reaction to

news is dependent on

the market’s state

(e.g., Conrad, Cor-

nell, & Landsman,

2002; Boyd, Hu, &

Jagannathan, 2005;

Docking & Koch,

2005; Mian & San-

karaguruswamy,

2012). We investigate

whether the market’s

reaction to earnings

news is dependent on

what investors have

seen in the past as

well as in the current market.

That is, is the market’s reaction

to earnings news sensitive to

whether the market is moving

in the same direction as the

past or is transitioning to a dif-

ferent direction? We find that

the price reaction to earnings

news is generally different

when the market continues in

the same state compared to

when it transitions to a differ-

ent state.

Empirically, various studies

show that investor behavior

with respect to pricing corpo-

rate news is influenced by the

market’s state. Docking and

Koch (2005) document more

aggressive investor

reaction to dividend

news that contradicts

the recent market

direction than to

news that confirms

the market. Conrad

et al. (2002) report

stronger reaction to

negative earnings

news in advancing

markets than in

declining markets,

but find no difference

in the reaction to

good news. Mian and

Sankaraguruswamy

(2012) report a stron-

ger price reaction to

positive (negative) news when

market sentiment is high (low)

than when sentiment is low

(high). Our research is closest

to Conrad et al. (2002) who

measure market movement by

the market’s P/E ratio in the

earnings announcement month

minus the average P/E ratio in

the past 12 months, and the

market is UP (DOWN) when

Refereed (Double-Blind

Peer Reviewed)

*JEL Classification: G12, G14, G39

We study whether the price reaction to earnings

news is sensitive to the past and the current

market states. Following advancing markets, the

reaction to positive earnings news is weaker when

the market continues advancing than when it

transitions to a declining state, while the reaction

to negative news is independent of the current

market state. Following declining markets, the

reaction to negative news is stronger when the

market continues declining than when it transitions

to an advancing state. In contrast, the reaction to

positive news is weaker when the market

continues declining than when it transitions to an

up state. Our results show that market dynamics

is an important determinant of investors’reaction

to earnings news. © 2018 Wiley Periodicals,Inc.

© 2018 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI 10.1002/jcaf.22343

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