Working Paper: NBER ID: w23883
Authors: Samuel M. Hartzmark; Kelly Shue
Abstract: A contrast effect occurs when the value of a previously-observed signal inversely biases perception of the next signal. We present the first evidence that contrast effects can distort prices in sophisticated and liquid markets. Investors mistakenly perceive earnings news today as more impressive if yesterday’s earnings surprise was bad and less impressive if yesterday’s surprise was good. A unique advantage of our financial setting is that we can identify contrast effects as an error in perceptions rather than expectations. Finally, we show that our results cannot be explained by a key alternative explanation involving information transmission from previous earnings announcements.
Keywords: contrast effects; financial markets; earnings announcements; behavioral finance
JEL Codes: D03; D91; G12; G14; G4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| return distortions (H31) | mispricing (D49) |
| return distortions (H31) | return correction over the next 50 trading days (G17) |
| previous day's earnings surprise (surpriset1) (C29) | return reaction to today's earnings surprise (G19) |
| previous day's earnings surprise (surpriset1) (C29) | return distortions (H31) |