Too Good to Be True? An Analysis of the Options Market's Reactions to Earnings Releases
19 Pages Posted: 30 Sep 2016
Date Written: July/August 2016
Using option implied risk neutral return distributions before and after earnings announcements, we study the option market's reaction to extreme events over earnings announcements. While earnings announcements generally reduce short‐term uncertainty about the stock price, very good news does not reduce uncertainty and slightly bad news actually increases uncertainty. We also find that left tail probabilities decrease over earnings releases while right tail probabilities increase. We interpret these findings as evidence of maintained investor expectations that very good news is generally not released during earnings announcements, combined with skepticism in the form of lingering uncertainty at the release of such very good news.
Keywords: earnings announcements, uncertainty resolution, option implied distributions, tail risk
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