Asymmetric Trading Costs Prior to Earnings Announcements: Implications for Price Discovery and Returns

We show the cost of trading on negative news relative to positive news increases prior to earnings announcements. Our evidence suggests this asymmetry is due to financial intermediaries’ preference to reduce their exposure to risks associated with the announcements. The asymmetry creates a predictable upward bias in prices that increases pre-announcement and subsequently reverses, which confounds short-window announcement returns as measures of risk premia and earnings news. Our findings provide a link between trading behavior, return patterns, and the information content of prices around earnings announcements and help to explain puzzling evidence in prior research that announcement risk premia precede the actual announcements. JEL Classifications: G10, G11, G12, G14, M41 ∗We thank Zhi Da, Emmanuel De George, Terry Hendershott, SP Kothari, Charles Lee, Russ Lundholm, Paul Tetlock and seminar participants at Cornell University, MIT, The University of Texas at Austin, London Business School, the 2014 Citi Quant Research Conference, Nasdaq Economic Research, and Stanford University for helpful feedback and suggestions. Portions of this research were previously included in a working paper titled “Earnings Announcement Premia: The Role of Asymmetric Liquidity Provision,” which has been split into multiple papers. 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. Asymmetric Trading Costs Prior to Earnings Announcements 1