A New Metric of Market Underreaction to Earnings Announcements: An Empirical Test*

This paper provides empirical evidence that the squared correlation coefficient between order imbalance and earnings surprise (COE) measures market underreaction and predicts the post-earnings announcement drift. We find strong evidence that COE during the announcement period predicts price movements (returns) during the post-announcement period in the expected direction. We find qualitatively similar results using risk-adjusted returns (i.e., Fama-French, Carhart, and Pastor-Stambaugh factor alphas), suggesting that well-known risk factors do not explain the profitability of trading strategy based on COE.