Earnings Announcement Premia: The Role of Asymmetric Liquidity Provision
نویسندگان
چکیده
This study examines the link between earnings announcement premia (i.e., higher returns in announcement periods) and changes in liquidity prior to the announcements. Motivated by prior research, we model market makers as holding positive inventories and show they asymmetrically raise costs of providing liquidity to sellers, relative to buyers, to reduce inventory risks ahead of earnings news. This asymmetry gives rise to the announcement premium by increasing the relative cost of trading on negative news. Consistent with our friction-based hypothesis, we show that equity prices predictably rise in the week prior to announcements and gradually decline following announcements. Our model also yields implications of this friction for trading activity, price dynamics, and the information content of prices, all of which we validate in our empirical tests. JEL Classifications: G10, G11, G12, G14, M41 ∗We thank SP Kothari and seminar participants at Cornell University and MIT for helpful feedback and suggestions. Corresponding authors: Travis Johnson, [email protected], 2110 Speedway Stop B6600, Austin, TX 78712 and Eric So, [email protected], E62-677 100 Main Street, Cambridge MA 02142. Earnings Announcement Premia: The Role of Asymmetric Liquidity Provision 1
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