Do Market-Based Contrast Effects Distort Return Reactions to Earnings Announcements?

Abstract

I analyze US data from 1984 to 2017 and find suggestive evidence of a negative relation between recent stock market performance and stock return reactions to earnings announcements. This could be explained by the psychological bias of contrast effects, where people contrast new information with what they recently observed: the investors’ perception of earnings news seems to be better if they have recently faced bad news in the stock market. Moreover, this relation seems to be separate from the inverse relation between recent earnings surprises and earnings announcement returns found by Hartzmark and Shue (2018). Thus, my results suggest that a very broad information set affects investors’ perceptions of news, and this leads to mispricings. Nevertheless, the statistical sig-nificance of my results is debatable.