Sequential Verification Theory: A Rational Framework for Momentum and Post-Earnings Announcement Drift

We present a unified rational framework for two of the most persistent anomalies in empirical finance: cross-sectional momentum and Post-Earnings Announcement Drift (PEAD). Part I introduces the theory of Kinetic Buffer Verification (KBV), which models momentum as the equilibrium price path generated by
a Sequential Probability Ratio Test (Wald, 1947). The market sequentially tests
whether a firm’s outperformance reflects a structural competitive buffer or transient cyclical luck. Momentum is the observable price adjustment caused by the
progressive rejection of the mean-reversion hypothesis. A Capital Efficiency Pivot
resolves the standard objection that declining risk should reduce returns: verified security frees precautionary capital for offensive redeployment, simultaneously raising
expected cash flows as the discount rate falls. Part II derives Rational Information Decay (RID) as the discrete, concentrated special case of KBV applied
to the earnings season. PEAD is the compressed verification cycle in which early
reporters resolve sector-level ambiguity, passive index flows transmit partial pricing
to unreported peers, and residual firm-specific drift reflects the time-cost of distinguishing structural moats from cyclical variance. An endogenous reporting-order
equilibrium rationalizes the empirical near-uniformity of PEAD magnitude across
the reporting calendar. The full framework employs Student-t copula dependence,
discrete-event summation, and a supply-chain spillover matrix. Fourteen falsifiable
predictions are derived across both anomalies, several of which are observationally
distinct from behavioral alternatives.