Monday, 8 September 2008

Heuristic-driven biases: 3. Anchoring

3. Anchoring

After forming an opinon, people are often unwilling to change it, even though they receive new information that is relevant.

Suppose that investors have formed an opinion that company A has above-average long-term earnings prospect. Suddenly, A reports much lower earnings than expected. Thanks to anchoring (also referred to as conservatism), investors will persist in the belief that the compny is above-average and will not react sufficiently to the bad news. So, on the day of earnings announcement the stock price would move very little. Gradually, however, the stock price would drift downwards over a period of time as investors shed their initial conservatism.

Anchoring manifests itself in a phenomenon called the "post-earnings announcement drift," which is well-documented empirically.

Companies that report unexpectedly bad (good) earnings news generally produce unusually low (high) returns after the announcement.

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