Abstract

We examine whether the predictability of future returns from past returns is due to the market's underreaction to information, in particular to past earnings news. Past return and past earnings surprise each predict large drifts in future returns after controlling for the other. Market risk, size, and book-to-market effects do not explain the drifts. There is little evidence of subsequent reversals in the returns of stocks with high price and earnings momentum. Security analysts ' earnings forecasts also respond sluggishly to past news, especially in the case of stocks with the worst past performance. The results suggest a market that responds only gradually to new information. AN EXTENSIVE BODY OF RECENT finance literature documents that the crosssection of stock returns is predictable based on past returns. For example, DeBondt and Thaler (1985, 1987)report that long-term past losers outperform long-term past winners over the subsequent three to five years. Jegadeesh (1990) and Lehmann (1990) find short-term return reversals. Jegadeesh and

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