Disclosure regulation and information risk

The present paper examines the impact of the Corporations Law Reform Act 1994 on information-based trading in Australian Stock Exchange-listed stocks. Results show that information-based trading is higher in the post-reform period, particularly for lower capitalization stocks. Further analysis shows that this is caused by a fall in turnover and rise in the number of slow trading days. After controlling for these factors, the reform is found to have no impact on information-based trading. Interestingly, the volume of price-sensitive disclosures is found to have no impact on either the level of information-based trading or market spreads.     

Chasing noise

We present a simple model in which rational but uninformed traders occasionally chase noise as if it were information, thereby amplifying sentiment shocks and moving prices away from fundamental values. In the model, noise traders can have an impact on market equilibrium disproportionate to their size in the market. The model offers a partial explanation for the surprisingly low market price of financial risk in the spring of 2007.     

Endogenous Information Acquisition with Cournot Competition

This paper studies information production in a model where both entry of analysts and their optimal information quality is endogenous. We show existence of the Bayesian–Nash equilibrium and solve for it in closed form. The model displays rich behavior. In particular, we find that the precision of an individual signal will always be bounded from above by the precision of the prior belief on payoff uncertainty. Furthermore, we give examples that contradict the naive intuition about information acquisition. For instance, we show how a change in the cost structure that makes information cheaper decreases price informativeness, while at the same time market liquidity and the amount of resources society spends on information acquisition can change either way. The model gives a simple, fully rational explanation on why the number of analysts following a stock can be quite large. Endogenizing the cost of information by allowing the manager to choose an optimal informational policy, we find a variety of optima that depend discontinuously on the model parameters. As a consequence, among two similar firms, one may find it optimal to attract many analysts, the other will cooperate with only a few.I am greatly indebted to Antonio Bernardo and Avanidhar Subrahmanyam, whose support, encouragement, insight, and many valuable comments made this paper possible. In addition, I also thank Justin Chan, Sudipto Dasgupta, Jason Hsu, Martin Nielsen, and Elena Sernova, the editor and an anonymous referee.     

Informed trading around earnings and mutual fund alphas

We examine whether informed trading around earnings announcements drives mutual fund performance. The measure is motivated by prior studies arguing that a mutual fund is skilled if it buys stocks with subsequent high earnings announcement returns. We find that this measure predicts future mutual fund returns. On average, after adjusting for Carhart’s four risk factors, the top decile of mutual funds outperforms the bottom decile by 44 basis points per quarter. By decomposing fund alphas into two components in their relations to earnings, we find that this measure is only associated with earnings-related fund alphas. This measure can also be used to predict stock returns at future earnings announcements.     

Empty voting and the efficiency of corporate governance

We model corporate voting outcomes when an informed trader, such as a hedge fund, can establish separate positions in a firm's shares and votes (empty voting). The positions are separated by borrowing shares on the record date, hedging economic exposure, or trading between record and voting dates. We find that the trader's presence can improve efficiency overall despite the fact that it sometimes ends up selling to a net short position and then voting to decrease firm value. An efficiency improvement is likely if other shareholders’ votes are not highly correlated with the correct decision or if it is relatively expensive to separate votes from shares on the record date. On the other hand, empty voting will tend to decrease efficiency if it is relatively inexpensive to separate votes from shares and other shareholders are likely to vote the right way.     

Endogenous liquidity in credit derivatives

We study the determination of liquidity provision in the single-name credit default swap (CDS) market as measured by the number of distinct dealers providing quotes. We find that liquidity is concentrated among large obligors and those near the investment-grade/speculative-grade cutoff. Consistent with endogenous liquidity provision by informed financial institutions, more liquidity is associated with obligors for which there is a greater information flow from the CDS market to the stock market ahead of major credit events. Furthermore, the level of information heterogeneity plays an important role in how liquidity provision responds to transaction demand and how liquidity is priced into the CDS premium.     

The generality of spurious predictability

Previous empirical work has documented significant predictability (non-zero cross autocorrelations) in short-term security returns. Extant theoretical papers have shown that these cross autocorrelations can arise due to partial impounding of information in securities whose returns are driven by a common factor. In this paper, we show that non-zero cross autocorrelation in security returns can arise under weaker conditions than is generally known. We demonstrate that the existence of cross autocorrelations crucially depends on the information structure of informed traders. Thus, a common factor in security returns is neither sufficient nor necessary. Any one of the following conditions on the information structure can generate non-zero cross autocorrelations:

(1) existence of an informed trader with information relevant to two securities;

(2) correlation in the signal of informed traders with information relevant to different securities; or

(3) correlation in uninformed trading.

These cross autocorrelations are then shown to be spurious. That is, traders without any private information cannot make positive trading profit by exploiting cross autocorrelations.     

An empirical investigation of trading on asymmetric information and heterogeneous prior beliefs

The purpose of this study is to identify and analyze inter-temporal trading patterns attributable to informed trading. Recent theoretical models posit that heterogeneous prior beliefs provide a source of trading volume in addition to the commonly accepted trading motives of liquidity and asymmetric information. After separating informed from uninformed trading using the estimation procedure of Easley et al. [Journal of Finance 51 (1996) 1405], we test for the presence of trading on heterogeneous beliefs as opposed to asymmetric information. The empirical findings confirm the existence of trading on heterogeneous prior beliefs and generally support the inter-temporal patterns proposed by Wang [Journal of Financial Markets 1 (1998) 321].     

Informed trading in public debt markets

This study examines the occurrence of informed trading in public debt issued by companies in the United States. I find that earnings surprises are positively associated with bond price changes prior to the release of financial report data to the public, for firms with non‐investment‐grade ratings. Additionally, I find that the effect appears to be driven by firms with publicly traded equity. Evidence further indicates an increase in trading activity during the time window between report period end date and filing date, for firms with larger earnings surprises.     

Does vega-neutral options trading contain information?

This study suggests a novel approach for decomposing net options demands into the options order imbalances with and without volatility risk. By analyzing a high-frequency index futures and options dataset, we examine the information content of (i) the direction-motivated order imbalance induced by a single option type, which is exposed to volatility risk, and (ii) that constructed by both calls and puts, which is vega-neutral. The aggregate options order imbalance does not convey information after controlling for futures market trading. However, the intraday options order imbalance by trading without volatility risk significantly predicts spot index returns, though its longer-horizon forecasting ability is relatively weak because of a possible cross-market hedging effect. The predictive abilities of informed foreigners’ trades and out-of-the-money options trading are prominent. Our empirical results suggest that the vega-neutral options trading conveys additional information distinct from the futures order imbalance.     

Are active fund managers collectors of private information or fast interpreters of public information?

Recent studies of fund manager performance find evidence of outperformance. However limited research exists as to whether such outperformance is because of privately collected information, or merely expedient interpretation of publicly released information. In this study, we examine the trade sequences of active Australian equity fund managers around earnings announcements to provide insights into the source of fund managers’ superior information. We document an increased occurrence of buy‐sell trade sequences around good‐news earnings announcements. The evidence is consistent with fund managers having both private information about forthcoming good‐news earnings announcements and being ‘short‐term profiteers’. We find no evidence that fund managers have private information about forthcoming bad‐news earnings announcements. However, we do find an increase in the frequency of fund managers not trading before bad‐news earnings announcements only to subsequently sell during announcements.     

Are margin traders informed?

The literature offers contradictory views on the informativeness of margin trading using various measures of information content. Utilising data from a Chinese margin‐trading pilot programme initiated in 2010, this paper investigates whether margin traders are informed by directly examining the return predictability of margin‐trading activity. We find that margin‐trading activities cannot positively predict future stock returns. Moreover, we explore some non‐informational trading strategies used by margin traders, e.g., positive‐feedback strategies and moving‐average trading rules. These results suggest that margin traders are noise traders rather than informed traders, and margin trading conveys no new firm‐specific information.