Information Uncertainty and the Post–Earnings Announcement Drift in Europe

Abstract

Investigating the effect of earnings announcement abnormal return and of abnormal trading volume on future returns for a large sample of European companies with both annual and interim announcements over 1997–2010, the author found that the two measures of market surprise are positively related to future abnormal returns, especially when information uncertainty is high. These two effects also appear to be complementary in that each retains some incremental predictive power for future returns.

This article investigates the relationship between earnings announcement abnormal returns, abnormal trading volume, and subsequent returns for a large sample of European companies with annual as well as interim announcements from January 1997 to June 2010. By quantifying the degree of surprise with some market-related information, I was able to alleviate several data issues, such as differences of accounting practices across European countries, and capture a wide range of information released at the time of the earnings announcement. In addition to bringing new insights for the dynamics of the abnormal return and abnormal trading volume effects, my analysis provides out-of-sample confirmations of several prior U.S. findings. I showed that each measure of market surprise is positively related to future abnormal returns. These two effects also appear to be relatively independent phenomena because each retains some incremental predictive power for future returns. Moreover, I found that information uncertainty plays an important role in determining the magnitude of the premiums earned by these strategies. I used the idiosyncratic volatility of stock returns as an outcome measure of information uncertainty and showed that both anomalies generate stronger abnormal returns in those stocks that experience larger degrees of specific risk. I also found that the positive premiums of a trading strategy based on the abnormal return and abnormal volume effects tend to cluster around periods that follow an increase in aggregate idiosyncratic risk. These results are in line with the view that behavioral biases are exacerbated in settings of heightened information uncertainty. An alternative, but not necessarily conflicting, explanation is that idiosyncratic volatility constitutes a limit to arbitrage that prevents investors from eliminating the premiums. Finally, I demonstrated that the main findings of my analysis are not limited to small illiquid stocks and are also robust to controlling for potential market microstructure biases.