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uncertainty resolution takes place well after the shock occurs, presumably because interest
rate, foreign exchange and commodity price shocks continue to affect earnings for several
quarters. 174
For firms with large ex-ante exposures, the absolute value of excess stock returns around
earnings’ announcements increases with the magnitude of recent quarter and lagged price
shocks. As Guay et al. [2002] suggest, this error in investors’ expectations likely stems
from either investors having incomplete information about firms’ risk exposures (and
therefore incomplete information about how an observed shock will affect firm’s earnings),
or investors’ failure to utilize available information about firms’ risk exposure, or both. 175
respectively. To put these magnitudes in perspective, the sample’s average absolute mean forecast revision
was 21.8% of actual earnings.
174 The failure of analysts to fully resolve the uncertainty created by these shocks is not surprising. To
perfectly map a given IR,FX, or commodity shock into earnings requires detailed and accurate information
about the firm-specific sensitivity of earnings to these shocks. For example, to anticipate how a shock to FX
will affect a corporation’s earnings requires detailed knowledge about all of the firm’s currency-exposed
contracts and currency hedging activities as well as the influence of this shock on competitive pressures,
product demand, and input prices (Guay et al., 2002).
175 Brown [2001] shows in his analysis on the risk management activities of a US based multinational
corporation (HDG Inc.) that a stated goal of the hedging program is to minimize the impact of changes in FX
rates on cash flows or reported earnings, because investors generally trade based on P/E ratio, with points
added to the multiple for higher growth, earnings and revenue consistency.
174