Is Post Earnings Announcement Drift A Priced Risk Factor in Emerging Markets? Chinese evidence

Abstract

This study examines the profitability of trading on earnings surprises in the postearnings announcement period for equities listed in the Shanghai and Shenzhen stock exchanges spanning the period 2000 to 2008 when Chinese markets were developing. The paper also examines whether the drift is a priced risk factor. We show that a postearnings announcement drift (PEAD) anomaly exists in China. We document that a hedge strategy of going long on stocks in the highest earnings surprise decile and going short on firms in the lowest earnings surprise decile generates 7.92% excess return in the 60 days following the earnings announcement. We also show that the PEAD is a priced risk factor. Our paper is the first to document that PEAD is systematically priced as a risk factor in stock returns. JEL classification: G11 G14 G15 M41Keywords: Post-earnings announcement drift, Earnings surprise, Divergence of opinion, Asset pricing INTRODUCTIONIn this paper we examine the profitability of trading on earnings surprises in the post-earnings announcement period for equities listed in the Shanghai and Shenzhen stock exchanges spanning the period 2000 to 2008. We also examine whether the PEAD is systematically priced as a risk factor in stock returns. We examine the significance of PEAD in the context of the onefactor and three-factor asset pricing models, as well as the enhanced one-factor and threefactor asset pricing models. We show that stock prices from the Chinese stock market have pronounced delayed reactions to earnings information. Specifically, a hedge strategy of going long the top decile of earnings surprise stocks and short the bottom decile of earnings surprise stocks can generate 7.92% excess return in the 60 days subsequent to earnings announcements. There is evidence that the magnitude of PEAD decreases in the level of market risk and increases in the level of trading volume as a proxy for transaction costs and liquidity. As far as the asset pricing tests are concerned we show that PEAD is a priced risk factor.