LO 6. Trading Strategies
Mechanistic or behavioural effect
Cosmetic Accounting
The market reacts mechanistically to changes in accounting numbers, regardless of whether they are cosmetic or they have cashflow implications
The market ignores accounting changes which have n cash flow consequences
Accounting Changes
a change in accounting for investment tax credits from deferral to immediate recognition
a switch back from accelerated depreciation to straight line depreciation
Post Announcement Drift
decline in trading rules
where abnormal returns can be obtained through trading on published accounting information
what is post announcement drift ?
occurs when the abnormal return continues after the announcement of profit, so the information content of the profit announcement does not fully reflect the stock price at the date of the announcement
Winner/Loser and overconfidence
what is it ?
an example of long-term anomaly association
This effect produces a trading strategy
Stocks that produce positive returns (winner) or negative returns (loser) are sorted based on the performance of the last 3 years and placements in portfolios
Too much trust in closed information also causes investors to minimize the importance of information disseminated to the public.
Furthermore, in the formation of expectations, investors hypothesize that it gives a lot of weight to the performance of previous company profits and is very little aware of the fact that future performance tends not to be the same as before
Manipulating Accounting Numbers
opportunistic perspective
cheating is the most extreme type of earnings management and is used by managers to deceive users of financial statements
Detecting the quality and probability of accounting management
The research by Sloan
the market does not have sophisticated accrual understanding and hence there is an overreaction to increase positive income accruals
Analyst reaction
Financial analysts can also be used to assess quality because of their expertise
However, this study states that analysts can be biased and focus on specific industry factors rather than specific company variables
The auditor's report and opinion can also be a proxy for quality but this is debated because the auditor is not necessarily truly independent