Information discreteness, price limits and earnings momentum

The earnings momentum generates remarkably high profits in Taiwan, a market that has been widely documented to exhibit no momentum premium for conventional momentum strategies. Using the measure of information discreteness (ID) to identify the information flows of stock prices, we find that higher magnitudes of earnings surprises tend to occur in firms that attract less investor attention. Taking advantage of this observation, we confirm the prediction of the underreaction hypothesis by showing that earnings momentum profits are higher among stocks with more continuous information that is ignored by investors. Further, we propose that price limits are related to ID because they represent attention-grabbing events. We examine a modification of ID by considering the effect of price limits to explicitly isolate the continuous information from the discrete information. The evidence based on this modification provides more robust support for the underreaction hypothesis and rejects the overreaction hypothesis in explaining the profitability of the earnings momentum in Taiwan. (C) 2016 Elsevier B.V. All rights reserved.