Small Trader Reactions to Consecutive Earnings Surprises: A Market Test of Behavioral Theory*

Several analytical models explain post-earnings-announcement drift, momentum and mean-reversion by making assumptions about investor behavior. They posit that investors react more strongly as a series of similar earnings surprises continues. Related literature suggests that behavior should vary systematically with investor sophistication. This paper tests these claims by analyzing whether traders on the NYSE exhibit increasing reactions to a series of similar earnings surprises, and whether their behavior varies with trade size, a proxy for sophistication. Results show that smaller traders exhibit an increasing reaction, with significant increases between the first, second, and third surprise. The pattern is weaker for larger trade-size groups, disappearing for the largest. Controls for prior returns show that small traders generally act as contrarians and large traders as momentum traders, strengthening the results. Future drift is weaker for each subsequent surprise in a series, suggesting that increasing reactions are not attempts to capitalize on increasing returns.