5. Geothermal corporation issued a press release before the stock market opened

Question

5. Geothermal corporation issued a press release before the stock market opened announcing that its earnings are above last year’s earnings. Explain how each of the following individual scenarios could be consistent with the semi-strong form of market efficiency.

(a) When trading opened after the announcement, the stock price quickly decreased by 20%.

(b) The stock price of Geothermal increased slowly over the 30 days before the announcement that earnings were higher than last year.

(c) The stock price decreased by 10% immediately following the announcement but then increased throughout the day so that the closing price was only 2% below the previous day.

Explanation / Answer

a. Since the stock prices quickly decreased by 20% this means that the market is reflective of all publicly available information and that is why when the announcement of earnings came it quickly reacted to the information.

b. In this case the market reveals the Strong form of market efficiency as it is reflective of sensing the insider information 30 days before the announcement.

c. This also reflects the Strong form of market efficiency as the market immediately reacted but then the abnormal returns vanished.

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