International Financial Reporting Standards and Noise Trading: Evidence from Central and Eastern European Countries

Abstract

Purpose – The purpose of this paper is to examine whether the mandatory adoption of International Financial Reporting Standards (IFRS) has produced an impact on the level of noise trading and volatility dynamics in three major central and eastern European (CEE) markets. Design/methodology/approach – The paper employs the theoretical framework proposed by Sentana and Wadhwani to allow the existence of both rational investors and trend‐chasing traders in examining the extent to which mandatory IFRS adoption affects the level of noise trading and volatility in the market place. Findings – The results show that noise trading was mostly significant prior to the IFRS introduction, with its significance dissipating following the implementation. Moreover, the paper finds that the level and persistence of stock return volatility has greatly decreased after the implementation of IFRS. Research limitations/implications – These findings are important in understanding the effect of IFRS adoption on the information environment and market dynamics and bear some important implications for the corporate managers, accounting professions and policy makers. For instance, the documented dissipation in noise trading post‐IFRS implies that the activity in the sample markets is dominated by rational fundamental investors for whom financial reports constitute part of their decision‐making input. Thus, it is crucial that the enforcement of IFRS constitutes a key priority of local authorities as a contributing factor to the efficiency and transparency of the market environment. Practical implications – The finding that moving towards the international accounting standards helps to improve the quality and stability of financial markets should provide a useful reference for many other countries which have recently introduced and/or been considering switching to IFRS as their mandatory accounting standards. Originality/value – This paper provides the first investigation of the effect of accounting standards’ harmonization upon the level of noise trading and volatility of three major transition markets (the Czech Republic, Hungary, and Poland) in the CEE area.