Information Shocks and Short-Term Market Underreaction

Using jumps in stock prices as a proxy for large information shocks, we provide evidence consistent with short-term underreaction in the US equity market. Strategies long (short) stocks with positive (negative) lagged jump returns earn significantly positive returns over the next one- to three-month horizons. The results based on intraday jumps, especially overnight jumps, provide further evidence consistent with underreaction. The underreaction is robust to controlling for other firm characteristics, extends stock return momentum over intermediate to short horizons, and captures market underreaction to information shocks beyond earnings surprises. We further show that limited investor attention contributes to short-term underreaction.