| I propose a novel explanation for short-term return continuation following public news, such as post earnings announcement drift. When investors place probabilities over a bounded set of firm productivities, disagreement causes the consensus opinion and the stock price under-react to public news. This belief structure is consistent with the widespread use by investors of categories, such as Buy/Sell/Hold recommendations or 'alpha-ranking' decision models. Disagreement induced under-reaction provides a straightforward mechanism for short-term return continuation anomalies, including post earnings announcement drift. I develop a model that makes a sharp, new, testable prediction. The more investors disagree about a firm, the more pronounced is the stock price under-reaction. Using dispersion of I/B/E/S long-term growth forecasts to proxy for disagreement, I find strong evidence linking post earnings announcement drift to differences of opinion. Consistent with the model, the return continuation is symmetric for good and bad news, a fact that can not be explained by models that rely on trading frictions, such as short sale constraints, to distort prices. |
