A study on the relationship between accounting anomalies and information uncertainty

Authors:Chia-Chung Chan, Yung-Ho Chang, Be-Yeen Chen

Journal: Chiao Da Management Review. Dec. 2006, 26(2): 155-186.

Keywords: Anomalies; Information uncertainty; Earnings quality

Abstract:
There is much debate over the existence and persistence of abnormal returns in finance-related field. Market efficiency suggests that rational traders should profit and close their positions immediately following public accounting signals. However, an increasing number of researchers have queried the authenticity of Capital Asset Pricing Model (CAPM) and efficient market hypotheses following numerous inconsistent empirical results since 1980’s. Among which accounting-based trading anomalies refer to systematic patterns in long term stock returns following an accounting signal which can be exploited to generate higher returns than expected. This study examines whether rational investors’ responses to information uncertainty explain accounting-based trading anomalies. We first construct short/long portfolios based on book-to-market, E/P, and cash flow-to-price ratios. We find that earnings quality is poor for both types of portfolios. The Stocks with poor earnings quality gain higher abnormal returns than those with good earnings quality. As information uncertainty is resolved over time, the abnormal returns to poor quality signals converge to the magnitude of the abnormal returns to good quality signals. The empirical evidence suggests that accounting-based trading anomalies are correlated with information uncertainty.