Explaining the Decline of PEAD: More Arbitrage or Less News? | CU Experts

Overview

Post-earnings-announcement drift (PEAD) has declined significantly over time. The prevailing explanation for this decline from prior work is an increase in arbitraging activities. We propose a new explanation based on a decline in the informativeness of current earnings news in predicting future earnings news (“signal informativeness”). We show that declining signal informativeness, particularly for smaller firms, plays a much more important role in the decline of PEAD than increasing arbitrage trading. In fact, when we account for declining signal informativeness alone, the downward trend in PEAD is no longer significant. Finally, we find that an increasing prevalence of firms with volatile earnings contributes most to declining signal informativeness, with the rise of special items playing a relatively minor role.