Article2018

A Tough Act to Follow: Contrast Effects in Financial Markets

115 citations0/0 files storedThe Journal of Finance

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Financial Markets and Investment Strategies Auditing, Earnings Management, Governance Decision-Making and Behavioral Economics

Abstract

ABSTRACT A contrast effect occurs when the value of a previously observed signal inversely biases perception of the next signal. We present the first evidence that contrast effects can distort prices in sophisticated and liquid markets. Investors mistakenly perceive earnings news today as more impressive if yesterday's earnings surprise was bad and less impressive if yesterday's surprise was good. A unique advantage of our financial setting is that we can identify contrast effects as an error in perceptions rather than expectations. Finally, we show that our results cannot be explained by an alternative explanation involving information transmission from previous earnings announcements.

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References

1979Prospect Theory: An Analysis of Decision under Risk 1988Prospect theory: An analysis of decision under risk 1992The Cross-Section of Expected Stock Returns 1968An Empirical Evaluation of Accounting Income Numbers 2007All That Glitters: The Effect of Attention and News on the Buying Behavior of Individual and Institutional Investors 1998Are Investors Reluctant to Realize Their Losses?1985The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence 1997Measuring Mutual Fund Performance with Characteristic‐Based Benchmarks

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