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A Tough Act to Follow: Contrast Effects in Financial Markets
Author(s) -
HARTZMARK SAMUEL M.,
SHUE KELLY
Publication year - 2018
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/jofi.12685
Subject(s) - yesterday , surprise , earnings surprise , earnings , contrast (vision) , perception , value (mathematics) , economics , monetary economics , financial economics , business , psychology , post earnings announcement drift , finance , social psychology , computer science , mathematics , earnings response coefficient , neuroscience , statistics , artificial intelligence , physics , astronomy
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.