Question

Corry did research to show stock return patterns. As he would expect, stocks with large positive earnings (winners) experience a positive return on the announcement day while stocks with large negative earnings surprises (losers) earn negative returns on the announcement day. More surprisingly, within the 20-day period prior to the earnings announcements, prices of winner stocks tend to go up while loser stocks experience negative returns. There is no evidence of changes in analyst expectations prior to the announcement, and there is also no evidence of other publicly known differences in the relevant factors for the valuation of winner and loser stocks. However, board members are usually informed about realized earnings before this information becomes public.

Based on this information, which of the following statements is correct?

	A.	Based on the return evidence prior to earnings announcements, you would tend to argue that markets are at best semi strong form efficient.
	B.	The market reaction on the announcement day suggests that markets overreact to new information.
	C.	The return evidence prior to earnings announcements can be used as evidence against semi strong form efficiency.
	D.	Because of the return differences prior to earnings announcements, you would tend to argue that markets are not even weak form efficient.
	E.	The positive returns of winners on the announcement day suggests a violation of weak form market efficiency.

Answer 1

The correct option is A, that is market is semi strong form efficient.

Efficient market is a well informed market. Means all earnings shocks, corporate issues, market conditions are already reflected in stock price. Actually that is difficult to achieve as there is always some shock element in market. Market starts predicting that a stock will be portraying positive earning this quarter and so it slowly starts to increase the stock price, but it may happen that the earning that is portrayed is bigger than estimation, so in that case there will be a shock element and on the announcement day it will react and jump a bit.

So though market is efficient, but it is not perfectly efficient, it is semi strong form efficient.