Underreaction or Risk? Expected Earnings and the Post-Earnings-Announcement Drift

This paper studies competing explanations for the Post-Earnings-Announcement Drift (PEAD) anomaly. We decompose analyst-forecast error into a component predictable by prior stock returns and a surprise component, with the predictable component interpreted as expected earnings. Under the investment-based asset-pricing explanation for PEAD, both components are related to future earnings and thus to expected returns. In contrast, under the investor underreaction explanation, PEAD is driven only by the surprise component. We find that purging the expected earnings component reduces PEAD profits by up to 54%, which suggests that a substantial part of the PEAD is consistent with investment-based asset pricing.