What Is the Announcement Effect?

The announcement effect is a shift in financial activity in response to news about a future event, whether negative or positive. It is also known as the signal effect. Research on this phenomenon looks at how people like investors and members of the general public respond to news and how this impacts financial markets. For people active in the financial industry, awareness of the announcement effect can influence decision making processes, with the goal of minimizing this effect and keeping the market stable.

A classic example of the announcement effect arises when a company announces an initial public offering, stock split, or dividend payment. Despite the fact that nothing about the company has functionally changed, investor activity tends to increase in response to the announcement. An uptick in trading can be seen, and the company's value may be driven up by this activity before trading returns to more normal levels. Anticipation of an announcement can create a similar effect, as traders wait to see what happens at a planned press conference or event.

Companies and government agencies consider the announcement effect when they prepare to make announcements. Increases in the interest rate, for instance, or issuance of new securities, must be timed carefully. If it is not handled well, an inflation in value may occur as traders jockey for position. The opposite could also happen; traders might view the announcement pessimistically and may drive prices down in the wake of the announcement.

Researchers with an interest in the announcement effect can track financial activities by looking at stock trading, financial reporting, and related information. Real-time examples occur constantly in markets across the world and allow researchers to see what happens in a number of situations. This research is used by everyone from companies timing the announcement of bad news to investors who want to be able to ride the announcement effect to profits by making strategic trades at the right time.

In insider trading cases, activities on the part of someone who has access to confidential information often reflect concerns about the announcement effect. For instance, if a city is considering the annexation of land to meet a need, and someone associated with this project starts to speculate in real estate, that person is counting on an anticipated rise in property values when the announcement goes public. This knowledge creates an unfair advantage, and it is thus illegal to act upon it.