Quick definition An announcement effect is the price movement caused by a news announcement. Earnings announcements, regulatory decisions, and merger news all cause announcement effects. What it is When important news is released, prices adjust rapidly. A company announces better-than-expected earnings and the stock jumps. The size and direction of the jump is the announcement effect. Large announcement effects indicate that the news was unexpected and contains significant information. Why it matters Announcement effects are a window into market efficiency. Markets that process information quickly have efficient price discovery. Markets that take time to process information are less efficient. Traders can profit from announcement effects if they can forecast the direction and magnitude. Pre-announcement drift Often, prices start moving before the official announcement, indicating that informed traders or news leaks reveal information early. Post-announcement drift occurs when prices continue drifting in the direction of the announcement for days or weeks. Magnitude of announcement effects Larger surprises create larger announcement effects. If earnings are slightly better than expected, the announcement effect is small. If earnings are much better, the effect is large. The market is skilled at judging the magnitude of surprises and pricing them correctly. Practical example A pharmaceutical company announces that a drug trial was successful. The stock immediately jumps 15 percent in the first hour after the announcement. This 15 percent move is the announcement effect. It represents the market's valuation of the positive news. If the market had already anticipated the success (efficient markets), the announcement effect would be small. Event studies Event study methodology uses announcement effects to measure information content and test market efficiency. Researchers measure abnormal returns (actual return minus expected return) around announcement dates. See also - Information Content - Price Discovery - Event Study - Post-Announcement Drift
