Price Dynamics on Earning Announcement

Abstract

In this chapter, we argue that under- and over-reaction are both parts of the price dynamics caused by investor's naïve judgmental extrapolation. We propose to use the Holt–Winters model, a parsimonious model with two parameters, to represent investor's conservatism (anchoring) and representativeness (trending). The complexity of earning information, which is broken down into a drift, a transitory shock, and an autocorrelated permanent shock, add further volatility to the price. We explain the price dynamics caused by the interplay of the earning model and investor's naïve belief. It is further argued that empirical “underreaction” and “overreaction” differ from true under- and overreaction. The simulated results with the proposed model confirm with empirical findings on under- and overreaction.

Citation

Huang, X. and Xu, N. (2013), "Price Dynamics on Earning Announcement", Lawrence, K.D. and Klimberg, R.K. (Ed.) Advances in Business and Management Forecasting (Advances in Business and Management Forecasting, Vol. 9), Emerald Group Publishing Limited, Leeds, pp. 59-75. https://doi.org/10.1108/S1477-4070(2013)0000009008