Timely Loss Recognition Helps Nothing

Abstract

This paper digests the relationship between the manipulation of losses and price reversals in the Chinese stock market. Timely loss recognition is involved in detecting the manipulation of losses, while price reversals are investigated by momentum profit. In addition, two-way sorting momentum portfolios are employed to connect manipulating losses with price reversals. Companies with low timely loss recognition aggressively manipulate their losses, and our results indicate that they generate much more significantly negative momentum profits. As a consequence, they cannot build up any immunity against reversal risks and encounter much higher reversal risks than other companies. Such findings still hold after the risk adjustments using asset pricing models come into play and when controlling for the calendar effect. This research indeed suggests that investors should exercise caution when dealing with companies whose financial information is too positive. Such companies may dress up their financial reports, thereby significantly increasing the risks associated with price reversals.