Short-Term Stock Reversals Around Earnings Announcements

Summary

The document describes a short-term reversal strategy around corporate earnings announcements. It focuses on large, liquid US stocks, ranks them by their returns in the days before an announcement, then buys recent losers and sells recent winners. The positions are equally weighted and held across the day before, the announcement day, and the day after.

The cited 1996–2011 study reports an average three-day return of 1.45% for this strategy, compared with 0.22% in randomly selected pseudo-announcement windows. The proposed explanation is that market makers face greater inventory risk before anticipated announcements and require more compensation for providing liquidity, followed by price reversal. The document does not establish whether the strategy hedges market downturns; it says more testing is needed to assess its risk and correlation characteristics. It also gives no treatment of trading costs or execution constraints.

Key ideas

• The strategy buys recent losers and sells recent winners among the largest stocks before earnings announcements.
• Positions are equally weighted and held from the day before through the day after the announcement.
• The cited study reports stronger short-term reversals around announcements than in random comparison periods.
• The proposed mechanism is increased compensation for liquidity provision when market makers face higher inventory risk.
• The document says the strategy’s market risk and potential hedging value are not established.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.