How Naive is the Stock Market's Use of Earnings Information?

Abstract

Rendleman Jones and Latane (1987) and Bernard and Thomas (1990) report evidence supporting their hypothesis that investors use a "naive" seasonal random walk model in forming expectations of quarterly earnings. Using the Bernard and Thomas (1990) data we show that the market acts as if it: (1) does not use a seasonal random walk model; (2) does incorporate past earnings changes in forming expectations; (3) does use the correct signs in exploiting serial correlation in seasonally-differenced quarterly earnings; but (4) underestimates the magnitude of the serial correlation. This evidence remains anomalous in the sense that it is consistent with neither the theory of efficient markets nor the "naive expectation model" hypothesis nor "behaviorial finance" theories.

JEL Classification: G41