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Management Forecasts, Disclosure Quality, and Market Efficiency
Jeffrey Ng, University of Pennsylvania
Irem Tuna, University of Pennsylvania
Rodrigo Verdi, Sloan School of Management MIT
ABSTRACT. We examine the future stock returns following management forecasts and the effect of disclosure quality on the magnitude of these returns. We find that investors underreact to forecast surprises. A post-management forecast drift trading strategy leveraging on this underreaction generates economically significant abnormal returns. These returns are robust to traditional asset pricing models and to the deduction of estimated transaction costs. We also find that the underreaction is greater for good news forecasts than for bad news forecasts, consistent with investors being more conservative in their reaction to good news forecasts due to their perception that good news is less credible. Finally, we provide evidence that higher quality disclosures, as proxied by prior forecast accuracy, are associated with a smaller underreaction.
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