Imagine holding a strong opinion about a stock, but the numbers prove you wrong. That tension you feel, that mental discomfort, is cognitive dissonance, and it turns out the stock market feels it too.
A recent study by Dr Odhrain McCarthy, a Trinity College Dublin graduate now at NYU Abu Dhabi, shows share prices often drift slowly after earnings announcements. This isn’t because of market frictions, but because investors resist changing their minds.
Hence, the title: Clinging to Beliefs in Financial Markets: Solving the Post-Earnings Announcement Drift Puzzle.
McCarthy finds that when a ‘sell’ stock reports unexpectedly strong profits, or a ‘buy’ favourite disappoints, prices adjust gradually over months.
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When news aligns with expectations, the drift is minimal. The effect in these “recommendation-inconsistent” cases can be four times larger than in ordinary scenarios. Why?
Overconfidence in prior beliefs and confirmation bias make investors cling to old opinions, suggests McCarthy, delaying the market’s collective admission of error.
The resulting hesitation creates opportunities for others: a simple strategy of buying ‘sell’ stocks with positive surprises and shorting ‘buy’ stocks that miss produces annual returns of 12 to 15 per cent.
Markets, it seems, don’t just trade on information. They trade on the time it takes to accept it.
