Earnings Announcement Premium

Fundamental reason

Research hypothesizes that the predictable rise in stock price is driven by the predictable rise in volume around the earnings announcements.

The earnings announcement premium is strongly related to the concentration of past trading activity around earnings announcement dates. In particular, stocks with a high volume around earnings announcements subsequently have both high premiums and high imputed buying by individual investors. This finding suggests that prices for some stocks are pushed higher around announcement dates by buying pressure from individuals.

Simple trading strategy

The investment universe consists of all stocks from the CRSP database. At the beginning of every calendar month, stocks are ranked in ascending order on the basis of the volume concentration ratio, which is defined as the volume of the previous 16 announcement months divided by the total volume in the previous 48 months. The ranked stocks are assigned to one of 5 quintile portfolios. Within each quintile, stocks are assigned to one of two portfolios (expected announcers and expected non-announcers) using the predicted announcement based on the previous year. All stocks are value-weighted within a given portfolio, and portfolios are rebalanced every calendar month to maintain value weights. The investor invests in a long-short portfolio, which is a zero-cost portfolio that holds the portfolio of high volume expected announcers and sells short the portfolio of high volume expected non-announcers.

Out-of-sample strategy's implementation/validation in QuantConnect's framework(chart, statistics & code)

Source paper

Frazzini, Lamont: The earnings announcement premium and trading volume

Abstract: On average, stock prices rise around scheduled earnings announcement dates. We show that this earnings announcement premium is large, robust, and strongly related to the fact that volume surges around announcement dates. Stocks with high past announcement period volume earn the highest announcement premium, suggesting some common underlying cause for both volume and the premium. We show that high premium stocks experience the highest levels of imputed small investor buying, suggesting that the premium is driven by buying by small investors when the announcement catches their attention.

Other papers

• Barber, De George, Lehavy, Trueman: The Earnings Announcement Premium Around the Globe

  Abstract: U.S. stocks have been shown to earn higher returns during earnings announcement months than during non-announcement months. We document that this earnings announcement premium exists across the globe. Using data from 46 countries, we find that the average stock return during earnings announcement months exceeds the return during non-announcement months by over 11 percent annually, after controlling for factors known to be associated with stock returns. The positive incremental return during earnings announcement months is not isolated to a few years; it is significant for 16 of the 20 years of our sample period. Moreover, it is not isolated to a few countries. Of the 20 countries with enough data to conduct a within-country analysis, nine exhibit a significantly positive premium. We also document that the premium for the smallest stocks exceeds that for the largest ones, by roughly 6 percent annually. As to potential explanations for the premium, we find evidence of an increase in the attention paid to firms around the time of earnings releases, creating upward pressure on stock prices. However, there is no evidence that higher levels of systematic or idiosyncratic risk around the time of earnings releases is a significant driver of the premium.

• Cohen, Dey, Lys, Sunder: Earnings Announcement Premia and the Limits to Arbitrage

  Abstract: We document that earnings announcement-day premia persist beyond the sample period of earlier studies, over different disclosure environments and remain robust to the refinement of using the expected announcement day rather than the actual announcement day. A portfolio of announcing firms yields returns in excess of the corresponding risk. Excluding announcers from a well-diversified portfolio, while reducing the standard deviation of that portfolio, also reduces its Sharpe ratio, indicating that this strategy results in a less favorable risk-return trade-off. Finally, we provide evidence that the premia are dramatically reduced when the announcement risk is reduced through preannouncements. In addition, we document that the continued presence of this premia is likely to result from limits to arbitrage. These findings are consistent with the view that the announcement period returns are likely to represent compensation for announcement risk.

• Johnson, So: Earnings Announcement Premia: The Role of Asymmetric Liquidity Provision

  Abstract: This study examines the link between earnings announcement premia (i.e., higher returns in announcement periods) and changes in liquidity prior to the announcements. Motivated by prior research, we model market makers as holding positive inventories and show they asymmetrically raise costs of providing liquidity to sellers, relative to buyers, to reduce inventory risks ahead of earnings news. This asymmetry gives rise to the announcement premium by increasing the relative cost of trading on negative news. Consistent with our friction-based hypothesis, we show that equity prices predictably rise in the week prior to announcements and gradually decline following announcements. Our model also yields implications of this friction for trading activity, price dynamics, and the information content of prices, all of which we validate in our empirical tests.

• Campbell, John L. and Zheng, Xin and Zhou, Dexin: Number of Numbers: Does Quantitative Disclosure Reduce Uncertainty in Quarterly Earnings Conference Calls?

  Abstract: Theoretical research argues that numbers convey more precise information than words. Based on this work, we hypothesize that when managers provide disclosure with a greater proportion of quantitative information in an earnings conference call, investor uncertainty around the call will be lower and, thus, short-window returns around the call will be higher. We offer three main findings. First, we find a positive association between the extent of hard information (i.e., numerical disclosure) in earnings conference calls and short-window stock returns around the call. This result suggests that investor uncertainty is lower when managers provide greater numerical disclosure. Second, we find that this positive association is larger when firms are smaller and have larger stock volatility or analyst forecast dispersion. These results suggest that the effect of numerical disclosure in reducing investor uncertainty is greater when the firm’s information environment is otherwise more uncertain. Finally, we find that this positive association is larger when firms issue a negative earnings surprise. This result suggests that the effect of numerical disclosure in reducing investor uncertainty is greater when the uncertainty of a firm’s performance is greater. Overall, our results suggest that investors react to the extent of hard information (i.e., numerical disclosure) in earnings conference calls.

• Liu, Hong and Mao, Yingdong and Tang, Xiaoxiao and Zhou, Guofu: Earnings Announcements: Ex-Ante Risk Premia

  Abstract: In this paper, we provide an estimate of the ex-ante risk premia on earnings announcements based on the option market. We find that the risk premia are time-varying and have predictive power on future stock returns. With our ex-ante risk premia as a measure of uncertainty before each earnings announcement, we find that the earnings-returns relation is much weaker when the uncertainty is high. The well-documented positive post-earnings-announcement drift (PEAD) is present only when the risk premia are high. After controlling for the announcement risk premia, the PEAD factor of the literature no longer has any abnormal returns. Moreover, while trading option straddles is not profitable unconditionally, conditional on high ex-ante risk premia, it becomes profitable even net of transaction costs.