News-driven return reversals: Liquidity provision ahead of earnings announcements

• Published in: Journal of financial economics Vol. 114; no. 1; pp. 20 - 35
• Main Authors: So, Eric C., Wang, Sean
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier B.V 01-10-2014; Elsevier Sequoia S.A
• Subjects: Demand; Earnings; Earnings announcements; Expected returns; Information; Inventories; Inventory risks; Investment returns; Liquidity; Liquidity provision; Market prices; Return predictability; Return reversals; Risk; Studies; Time series; Return predictability; G11; G10; G12; Return reversals; G14; M41; Inventory risks; Liquidity provision
• ISSN: 0304-405X; 1879-2774
• DOI: 10.1016/j.jfineco.2014.06.009

This study documents a six-fold increase in short-term return reversals during earnings announcements relative to non-announcement periods. Following prior research, we use reversals as a proxy for expected returns market makers demand for providing liquidity. Our findings highlight significant time-series variation in the magnitude of short-term return reversals and suggest that market makers demand higher expected returns prior to earnings announcements because of increased inventory risks that stem from holding net positions through the release of anticipated earnings news. Collectively, our findings suggest that uncertainty regarding anticipated information events elicits predictable increases in the compensation demanded for providing liquidity and that these increases significantly affect the dynamics and information content of market prices.