Earnings Announcement Premia and the Limits to Arbitrage

Abstract

We document that earnings announcement-day premia persist beyond the sample period of earlier studies, over different disclosure environments and remain robust to the refinement of using the expected announcement day rather than the actual announcement day. A portfolio of announcing firms yields returns in excess of the corresponding risk. Excluding announcers from a well-diversified portfolio, while reducing the standard deviation of that portfolio, also reduces its Sharpe ratio, indicating that this strategy results in a less favorable risk-return trade-off. Finally, we provide evidence that the premia are dramatically reduced when the announcement risk is reduced through preannouncements. In addition, we document that the continued presence of this premia is likely to result from limits to arbitrage. These findings are consistent with the view that the announcement period returns are likely to represent compensation for announcement risk.