The clocks going forward gives armchair investors a chance to cash in on stock market movements as sleep-deprived traders are slower to react to company updates, a study has found.
The loss of just one hour’s sleep results in markets underpricing the shares of affected companies by 36pc, according research conducted by the University of Edinburgh.
Ahead of company announcements, capital markets speculate on what they think will happen. When firms deviate from these predictions what is known as an “earnings surprise” occurs.
How fast and accurately traders react to these unpredictable events, impacts the pricing of a company’s shares.
The study, published in the European Journal of Finance, found that when these events coincided with the loss of sleep, markets took longer than normal to price the new information into stock market valuations.
This suggests sleep-deprived traders are initially mispricing impacted companies before revisiting the information and pricing differently.
The gap between companies releasing an announcement and reaching their correct market valuation can be around 10 days, leaving a window of time for savvy investors to take advantage and buy undervalued stock following an announcement and then benefit from a later market repricing, the study said.
The team who conducted the study says its findings highlight the vital role that investors’ cognitive ability – specifically reasoning and processing speed – plays in efficient market pricing.
In order to reach their findings, the researchers studied a large sample of earnings announcements, made between 1993 and 2018, in the wake of the spring clocks reset.
These were then contrasted with earnings forecasts made at the time. Unexpected increases in earnings within the target group were then compared with a control group of similar companies that had announced financial results exactly one week earlier.
Angelica Gonzales, senior lecturer in finance at the university, said the findings of the study were “consistent with investors revisiting – and reversing – their initial underreaction to earnings surprises”.
“Since the reversal is evident as early as 10 days post-announcement, this suggests the return patterns can be explained by investors revisiting the original earnings surprise as their sleep recovers – rather than the arrival of new information.”
Analysis from the study indicated that investors suffering from sleep deprivation may avoid making difficult investment decisions such as trading on earnings announcements.
This might amount to an “limited attention” effect that has been shown to result in announcement underreaction to earnings news and post-announcement drifts, it said.
