Does the increasing attention to cryptocurrencies divert investor attention away from the traditional equity market? In our recent paper, we study whether attention to cryptocurrency impacts information processing and price efficiency in the equity market.
The cryptocurrency market has grown from $17 billion at the beginning of 2017 to $2.2 trillion at the end of 2021. The exponential growth in crypto markets has attracted investors, regulators, and academics in the recent years. In April 2022, the Securities and Exchange Commission (SEC) announced new crypto regulation initiatives to expand investor protection in the cryptocurrency markets. Current academic research examines the arbitrage opportunities, bitcoin transaction fees, investor trading patterns, and smart contracts in the blockchain technology. These studies are all primarily focused on the cryptocurrency market in isolation. Thus, it is not well understood whether and how the cryptocurrency market influence other markets, including the equity market. To understand the spillover effects of cryptocurrency on equity markets, we examine if the distraction towards cryptocurrency markets influences the pricing of earnings information.
￼Recent studies provide evidence that when there are events competing for investor attention, prices do not immediately impound earnings news. According to the above argument and evidence, the surge in interest in cryptocurrency in recent years may also divert investors’ attention away from gathering and processing value-relevant information in the equity market, even during key information events—earnings announcements. Thus, we hypothesize that investors pay less attention and underreact to earnings news when cryptocurrency captures their attention. We call this prediction the distraction hypothesis.
Using cryptocurrency price movements to proxy for investor attention to cryptocurrency, we test the distraction hypothesis. We employ two empirical measures for attention to cryptocurrency: (1) the cumulative returns of Bitcoin and (2) the cumulative returns of the four major cryptocurrencies (i.e., Bitcoin, Ethereum, Binance Coin, and Cardano). We define both measures over the ten-day window before earnings announcements. Our motivation for using these measures is based on the fact the performance of cryptocurrencies is often covered by financial media and social media. Inspired by the fact that extreme returns catch investors’ attention, we also use the maximum cumulative returns as alternative measures (i.e., maximum cumulative returns of Bitcoin and four major cryptocurrencies over the ten days before earnings announcements).
Using a sample of quarterly earnings announcements from 2016 to 2020, we investigate whether cryptocurrency distracts investors around earnings announcements. We find that the market reaction to earnings surprise is muted when there is intense cryptocurrency distraction. We conduct cross-sectional analyses to better understand the effect of cryptocurrency distraction on reactions to earnings news. We find that the distraction effect is more pronounced when the past equity market volatility is higher and the past stock return is lower, indicating that investors are more likely to be distracted when equity market conditions are adverse. In addition, we show that post–earnings-announcement drift (PEAD) is more prominent on high-distraction days, indicating lower price efficiency. Collectively, the evidence suggests that cryptocurrency distracts investor attention around earnings announcements and attenuates the market reaction to earnings news.
Further, using two direct measures of investor attention, we find that limited attention can explain the underreaction to earnings news. Because researchers cannot directly observe each individual’s attention allocation, existing studies have used trading volume as a measure of investor attention. We show that the abnormal trading volume around earnings announcements is negatively associated with past cryptocurrency returns, indicating greater distraction. In addition, we use Google search volume as an alternative measure of equity investor attention and find that the Google search volume for stocks around earnings announcements is lower on high-distraction days.
Overall, this paper studies the disruption effect of cryptocurrency on information processing in the equity market, contributing to the understanding of cryptocurrency mania and its consequences. In light of the growing calls for studies on digital currencies and intensive effort on developing cryptocurrency regulation, the findings of this paper provide timely evidence about the consequences of cryptocurrency mania to regulators, researchers, and practitioners.
Our findings add to the growing literature on investor information processing by documenting the impact of cryptocurrency distraction on the extent to which stock prices incorporate public information. One unique feature of cryptocurrency is that its fundamental value is generally not associated with any underlying assets, and thus its pricing is difficult to predict and less likely to be linked with firm fundamentals. Utilizing this setting, our paper provides direct evidence of the limited attention theory. Overall, we provide evidence that attention to cryptocurrency impacts information processing and price efficiency in the equity market around earnings announcements.
Minjae Kim is a PhD candidate at the Carlson School of Management of the University of Minnesota, Twin Cities.
Eva (Hui) Liang is an Assistant Professor of Accounting at the Soules College of Business of the University of Texas at Tyler.
Ashish Ochani is a PhD candidate at the Samuel Curtis Johnson Graduate School of Management of the Cornell University.
Xinyuan Shao is a PhD candidate at the Carlson School of Management of the University of Minnesota, Twin Cities.
This post is adapted from their paper, “Cryptocurrency Disruption and Investor Reaction to Earnings Announcements” available on SSRN.
The views expressed in this post are those of the author and do not represent the views of the Global Financial Markets Center or Duke Law.