Can Investors Create Profitable Trading Strategies Based on Academic Findings?
Skip to content
Finance & Accounting May 6, 2022

Can Investors Create Profitable Trading Strategies Based on Academic Findings?

It hasn’t been clear if information from the ivory tower translates to the trading-room floor. A new study tackles the question by looking at research on earnings announcements.

stock trader surrounded by computer monitors

Yevgenia Nayberg

Based on the research of

Matthew R. Lyle

Teri L. Yohn

There has been a large volume of academic research suggesting that an investor can use stock-return patterns around corporate-earnings announcements to create a profitable trading strategy.

“There have been a ton of studies around earnings announcements, and the evidence is pretty compelling,” says Matthew Lyle, an associate professor of accounting information and management at Kellogg. However, “these studies aren’t necessarily designed to mimic how traders actually act or what information they truly incorporate into their decisions.”

So Lyle and coauthor Teri Lombardi Yohn, at Emory University, set out to see whether investors could use the research findings around earnings announcements to make profitable trades. They worked hard to keep the investor’s perspective in mind. As they write in their paper, they wanted to create “a method that more closely resembles implementable trading strategies” than past research has done.

They did this by creating portfolios populated by historical trading data in order to mimic a plausible investor portfolio and then applying a “train-test approach” (common in machine learning) to simulate the various ways a real investor might attempt to trade on earnings-announcement news. This allowed the researchers to discern how an investor might best gain returns from the stock-movement patterns that tend to either precede or follow earnings announcements.

They looked in particular at three general findings from previous academic research to see how useful each of them might be to a typical investor.

Lyle and Yohn’s analysis found that some—but not all—panned out as a useful trading strategy. But more broadly, their findings supported the idea that actual investors could profit from understanding these stock-movement patterns.

“The paper addresses, I believe for the first time, the question, ‘Is something actually economically there when it comes to the research findings about earnings announcements?’” Lyle says. “And the answer is yes.”

Simulating Real Investors

Lyle says the most challenging part of the study was designing it with an investor’s perspective at the forefront—and accounting for what they are, and are not, likely to know in the moment as they make trading decisions.

For example, in creating their portfolios and designing their train-test approach, the researchers elected to assume that the imagined investor was aware of the three key patterns around earnings announcements that have been documented in past research. These findings were:

1) After a company reports surprising earnings, that company’s stock tends to drift for a few days or even weeks—up for positive surprises, down for negative ones.

2) A company’s stock price generally gets a boost in the lead-up to earnings announcements, perhaps because more investors are thinking about it.

3) Earnings tend to be more positively surprising when an earnings announcement is moved up from its expected date—and more negatively surprising when the announcement is delayed, suggesting that firms appear more eager to share good news than bad.

“From an investor’s perspective, as you go into today, you only have the information based on today, and based on the past, to actually trade on. You don’t get to see tomorrow.”

— Matthew Lyle

Lyle and Yohn’s imagined investor might wonder, could an investment strategy trade off of all three patterns at once? Should one or two take primacy over the others? Lyle says previous research hasn’t addressed these questions.

Often studies assume that investors have no knowledge of the earnings-announcement patterns found in previous research. This seemed unlikely to Lyle and Yohn. At the same time, Lyle argues, many of the common approaches used in these studies also assume that an investor has too much knowledge.

For example, many of these studies rely on what is called an “event time” approach, which groups together events that happened within a given time period—and treats those events as though they happened at the same time.

Event time is clever for helping researchers make sense of stock-market movements, Lyle says, “but from an investor’s perspective, as you go into today, you only have the information based on today, and based on the past, to actually trade on. You don’t get to see tomorrow.”

Lyle and Yohn sought to address the limitations of this “look-ahead bias” by instead relying only on what an investor would have actually known on any given day.

The researchers also had their simulated portfolios hold at least 30 stocks. This was intended to mimic the real-life diversification that many investors are mindful of, as opposed to less diversified and less realistic portfolios that academics often use.

In their portfolios, the researchers’ train-test approach simulated various ways an investor might attempt to trade on earnings-announcement news. In some portfolios, for example, they allowed for a long lag after earnings news hit before trading a stock—since some past research has suggested that a stock’s post-earnings announcement drift can last several weeks. In others, they moved more quickly. From there, the researchers were able to zero in on the most profitable strategies.

A Dominant Pattern

The researchers’ findings reveal some interesting insights for implementing trading strategies around earnings announcements.

First, they found that a stock’s post-earnings-announcement drift pattern can generally be profitably traded on for the first one to four days. This is a much smaller window for trading on earnings-announcement updates than suggested in previous research.

What’s more, it appears that investors are best off when they only pay attention to the post-earnings-announcement drift patterns—rather than also trying to incorporate the patterns in stocks’ movement just before these announcements or in the event of a rescheduling. Lyle acknowledges that this surprised him; he had assumed that the most profitable strategies would be the ones that managed to incorporate more than one of these documented patterns.

In the end, he says, he believes the non-post-announcement drift patterns do not prove incrementally useful because it’s essentially a trade-off: when an investor chooses to invest, that investor must give up something, and since the patterns overlap across different firms for much of the time, it behooves investors to choose the one that tends to produce the most stock movement, which is the post-earnings-announcement drift pattern.

The underlying reasons why this pattern was the dominant one were not addressed by this paper—and Lyle hopes that the study helps to provide a new way of examining the reasons in future research.

A Message to Future Researchers

Lyle believes his findings have important messages to convey.

The first is for investors: even after designing a methodology that integrated many of the constraints that real investors deal with, Lyle and Yohn still found potentially profitable strategies in patterns surrounding earnings announcements. To Lyle, this suggests that “some of the results in the academic literature do appear to be real and remarkably robust.”

Lyle says the other central message of his paper is for academics: it may be time to update some of the common methodologies used in this realm of research that are preventing results from being generalizable to real investors.

“I think if we want to say something about how much an investor is leaving on the table, it’s important for us to provide some guidance on how they would actually trade based on the patterns identified in academic research.”

Featured Faculty

Previously a member of the Accounting faculty at Kellogg

Previously a Visiting Professor of Accounting at Kellogg

About the Writer

Katie Gilbert is a freelance writer in Philadelphia.

About the Research

Lyle, Matthew, and Teri L. Yohn. 2022. “Measuring Portfolio Gains from Earnings Announcement Trading Signals.” Working paper.

Read the original

Most Popular This Week
  1. How Are Black–White Biracial People Perceived in Terms of Race?
    Understanding the answer—and why black and white Americans may percieve biracial people differently—is increasingly important in a multiracial society.
    How are biracial people perceived in terms of race
  2. Don’t Wait to Be Asked: Lead
    A roadmap for increasing your influence at work.
    An employee leads by jumping from the bleachers and joining the action.
  3. How (Not) to Change Someone’s Mind
    Psychologists have found two persuasion tactics that work. But put them together and the magic is lost.
    A woman on a street talks through a large megaphone.
  4. Which Form of Government Is Best?
    Democracies may not outlast dictatorships, but they adapt better.
    Is democracy the best form of government?
  5. How Autocracies Unravel
    Over time, leaders grow more repressive and cling to yes-men—a cycle that’s playing out today in Putin’s Russia.
    autocrat leaning over battle map surrounded by yes-men.
  6. Knowing Your Boss’s Salary Can Make You Work Harder—or Slack Off
    Your level of motivation depends on whether you have a fair shot at getting promoted yourself.
    person climbin ladder with missing rungs toward rich boss surrounded by money bags on platform
  7. Sitting Near a High-Performer Can Make You Better at Your Job
    “Spillover” from certain coworkers can boost our productivity—or jeopardize our employment.
    The spillover effect in offices impacts workers in close physical proximity.
  8. It’s Performance Review Time. Which Ranking System Is Best for Your Team?
    A look at the benefits and downsides of two different approaches.
    An employee builds a staircase for his boss.
  9. Will AI Eventually Replace Doctors?
    Maybe not entirely. But the doctor–patient relationship is likely to change dramatically.
    doctors offices in small nodules
  10. Why Do Some People Succeed after Failing, While Others Continue to Flounder?
    A new study dispels some of the mystery behind success after failure.
    Scientists build a staircase from paper
  11. Four Strategies for Cultivating Strong Leaders Internally
    A retired brigadier general explains how companies can prioritize talent development.
    Companies should adopt intentional leadership strategies since developing leaders internally is critical to success.
  12. Take 5: Not So Fast!
    A little patience can lead to better ideas, stronger organizations, and more-ethical conduct at work.
  13. Too Much Cross Talk. Too Little Creativity. How to Fix the Worst Parts of a Virtual Meeting.
    Six tools from an unlikely place—improv comedy—to use on your next Zoom call.
    meeting participants improv
  14. Take 5: How to Be Prepared for Important Career Moments
    Expert advice on getting ready to network, negotiate, or make your case to the CEO.
    How to be prepared
  15. Entrepreneurship Through Acquisition Is Still Entrepreneurship
    ETA is one of the fastest-growing paths to entrepreneurship. Here's how to think about it.
    An entrepreneur strides toward a business for sale.
  16. Why Do Long Wars Happen?
    War is a highly inefficient way of dividing contested resources—yet conflicts endure when there are powerful incentives to feign strength.
    long line of soldiers marching single file through a field
  17. 5 Tips for Growing as a Leader without Burning Yourself Out
    A leadership coach and former CEO on how to take a holistic approach to your career.
    father picking up kids from school
  18. 2 Factors Will Determine How Much AI Transforms Our Economy
    They’ll also dictate how workers stand to fare.
    robot waiter serves couple in restaurant
  19. What Went Wrong at AIG?
    Unpacking the insurance giant's collapse during the 2008 financial crisis.
    What went wrong during the AIG financial crisis?
More in Business Insights Finance & Accounting