The more we know about fundamentals the less we agree on price? Evidence from earnings announcements.

Abstract

This study investigates whether an earnings announcement that decreases disagreement about fundamentals can simultaneously increase disagreement about price. Kondor (2012) develops a rational expectations model in which the presence of short-horizon investors can lead to a polarization of higher-order beliefs about price (i.e., beliefs regarding the opinions of other investors), even as a public announcement reduces disagreement about fundamentals. I empirically investigate this theoretical finding using analyst forecast dispersion and implied volatility to proxy for differences of opinion about fundamentals and price, respectively. I predict and find a positive association between the presence of short-horizon traders and both the likelihood and extent of divergence between changes in price disagreement and earnings disagreement around earnings announcements characterized by decreasing forecast dispersion (i.e. earnings announcements that decrease disagreement about fundamentals). Further, I document that the association is stronger following good news announcements than following bad news announcements consistent with more precise public signals triggering higher-order disagreement. In additional analysis, I employ abnormal announcement period volume to measure disagreement about price. Using this alternative measure, I continue to document a positive association between short-horizon ownership and the extent of divergence. Taken together, these findings suggest that higher-order beliefs play an important role in the way market participants react to public announcements.