Market Efficiency, Bounded Rationality, and Supplemental Business Reporting Disclosures

The AICPA Special Committee on Financial Reporting has urged disclosure of relevant forward-looking information on risks and opportunities to supplement conventional financial statements. We conduct a laboratory market experiment to assess the effects of such disclosures on capital allocation decisions. We develop two sets of competing hypotheses regarding how capital markets react to supplemental disclosures. One set is based on the assumption of semi-strong market efficiency, while the other posits that the bounded rationality of individual traders leads to inefficient market prices. We find that explicit disclosure of management's best estimate of an uncertain quantity improves market efficiency, even though this disclosure is redundant with information in financial statements. Second, we find disclosure of an upper bound of management's estimate has the potential to bias security prices upward, while informationally equivalent disclosure of both upper and lower bounds removes this bias. These results suggest that experimental market reactions to these supplemental disclosures are inconsistent with market efficiency. Supplemental analyses of individuals' price predictions and trading behavior support our conclusion that inefficiencies are at least partially attributable to individual information processing biases.     

投资者关注与市场反应——来自中国证券交易所交易公开信息的自然实验

涨停的股票能否被交易公开信息披露取决于收益率排名中的随机因素,与股票的基本面特征无关。本文利用这一机制设计自然实验检验了投资者关注对股价的影响。实证结果显示交易公开信息披露使股票受到投资者更多的关注,增加了小额资金的净流入,减少了大额资金的净流入和股价的短期收益率,抑制了股价短期波动率,同时降低了股价在长期发生反转的可能性。频繁登上交易公开信息的知名营业部买入的股票受到更多关注,相应的市场反应也更加显著。进一步的研究表明监管性信息披露引发的投资者关注通过降低市场信息不对称抑制了股价反转。     

Good disclosure,bad disclosure

We study real-efficiency implications of disclosing public information in a model with multiple dimensions of uncertainty where market prices convey information to a real decision maker. Paradoxically, when disclosure concerns a variable that the real decision maker cares to learn about, disclosure negatively affects price informativeness, and in markets that are effective in aggregating private information, this negative price-informativeness effect can dominate so that better disclosure negatively impacts real efficiency. When disclosure concerns a variable that the real decision maker already knows much about, disclosure always improves price informativeness and real efficiency. Our analysis has important empirical and policy implications for different contexts such as disclosure of stress test information and regulation of credit ratings.     

Belief diversity and price informativeness around earnings announcements

The consequences of price informativeness have been extensively studied in the past. In contrast, this study goes a step backward to explore its determinants by examining whether belief diversity facilitates a complete and timely reflection of earnings news into prices. Using a global dataset, we find a higher abnormal return variance ratio (lower post-earnings announcement drift) in the presence of more diversely-informed beliefs among traders. This inference holds despite several robustness checks. Moreover, the cross-country analysis reveals that the documented impact of belief diversity intensifies in countries with higher market development, greater corporate transparency, and stronger investor protection.     

Investor Sentiment,Trading Behavior and Informational Efficiency in Index Futures Markets

This paper shows that traders in index futures markets are positive feedback traders—they buy when prices increase and sell when prices decline. Positive feedback trading appears to be more active in periods of high investor sentiment. This finding is consistent with the notion that feedback trading is driven by expectations of noise traders. Consistent with the noise trading hypothesis, order flow in index futures markets is less informative when investors are optimistic. Transitory volatility measured at high frequencies also appears to decline in periods of bullish sentiment, suggesting that sentiment‐driven trading increases market liquidity.     

INFORMATION AND NOISE IN FINANCIAL MARKETS: EVIDENCE FROM THE E‐MINI INDEX FUTURES

I examine the informational contributions and effects on transitory volatility of trades initiated by different types of traders in three actively traded index futures markets. The results show that trades initiated by exchange member firms account for more than 60% of price discovery during the trading day. These institutional trades appear to be more informative than trades of individual exchange members or off‐exchange traders. I also find that off‐exchange traders introduce more noise into the prices than do exchange members. My findings provide new evidence on the role of different types of traders in the price formation process.     

Investor protection and price informativeness about future earnings: international evidence

This study draws on the investor protection literature to identify structural factors in a country’s information environment that are likely to explain cross-country differences in the extent to which future earnings information is capitalized in current stock returns. Using a sample of 55,900 firm-years from 32 countries, we find that greater financial disclosure, higher quality earnings, and greater information dissemination through news media are associated with stock prices that are more informative about future earnings, whereas strong enforcement of insider trading laws is associated with stock prices that are less informative about future earnings. We also find that, on average, price informativeness about future earnings is greater in countries with strong investor protection. Our results illuminate the importance of structural factors constituting a country’s information environment in explaining cross-country variation in price informativeness about future earnings.     

Market uncertainty and the importance of media coverage at earnings announcements

We investigate whether increased investor demand for financial information arising from higher market uncertainty leads to greater media coverage of earnings announcements. We also investigate whether greater coverage during times of higher uncertainty further destabilizes financial markets because of greater attention-based trading or, alternatively, improves trading and pricing by lowering investor acquisition and interpretation costs. When uncertainty is higher, we find evidence of greater media coverage of earnings announcements and that the greater coverage leads to improvements in investor informedness, information asymmetry, and intraperiod price timeliness, and greater trade by both retail and institutional investors. In contrast to the media serving an expanded role in improving capital markets during more uncertain times, we fail to find that changes in firm-initiated disclosures lead to similar improvements and find that less frequent analyst forecast revisions exacerbate problems in capital markets during earnings announcements.     

The incremental information content of non-US GAAP earnings disclosures: Evidence from UK firms

This paper examines price and trading volume responses in the US equity market to the preliminary earnings announcements (PEAs) in the UK of UK firms listed on US exchanges (e.g., NYSE and AMEX). The inquiry focuses on whether the return forecast error (absolute and squared values) and volume residual (standardized and unstandardized) for each day were significantly different from the average on the day of the earnings announcements (PEA). The most significantly unexpected return occurred the day prior to the Financial Times (FT) announcement. The results suggest prompt volume and price responses to the UK PEAs in the US security market. Excess trading volume occurred the day prior to and the day of the FT release price response occurred on the day subsequent to the PEAs. This may suggests that investors possess differential prior beliefs or likelihood functions in evaluating public disclosure. Consistent with Frost and Pownall [Frost, C., & Pownall, G. (1996), Interdependencies in the global markets for capital and information: The case of Smithkline Beecham plc. Accounting Horizons, 1, 38-57], US investors seem not to be confused by US/UK generally accepted accounting principles (GAAP) differences, and in fact use information about UK GAAP earnings in their valuations and trading decisions. This implies that traders correctly use UK accounting output to the determination of values in setting security prices and arriving at trading decisions. Broadly, these findings support the assumption that disclosures by UK-listed firms in their domestic market influence share liquidity and trading in the US market.     

The stock price effects of changes in dispersion of investor beliefs during earnings announcements

Existing research provides competing theories about how dispersion of investor beliefs might affect stock prices. We measure changes in dispersion of investor beliefs around earnings announcements using changes in the dispersion of individual analysts’ forecasts. We find that the 3-day market response to earnings announcements is negatively associated with changes in dispersion, consistent with the cost of capital hypothesis. The results hold after controlling for the current earnings surprise, forecast revisions of future earnings, and reported earnings relative to various earnings thresholds. Our study provides new insight about the information contained in earnings announcements that is incremental to the magnitude and timing of cash flows.     

Volume, Volatility, Price, and Profit When All Traders Are Above Average

People are overconfident. Overconfidence affects financial markets. How depends on who in the market is overconfident and on how information is distributed. This paper examines markets in which price-taking traders, a strategic-trading insider, and risk-averse marketmakers are overconfident. Overconfidence increases expected trading volume, increases market depth, and decreases the expected utility of overconfident traders. Its effect on volatility and price quality depend on who is overconfident. Overconfident traders can cause markets to underreact to the information of rational traders. Markets also underreact to abstract, statistical, and highly relevant information, and they overreact to salient, anecdotal, and less relevant information.     

Price dispersion in OTC markets: A new measure of liquidity

In this paper, we model price dispersion effects in over-the-counter (OTC) markets to show that, in the presence of inventory risk for dealers and search costs for investors, traded prices may deviate from the expected market valuation of an asset. We interpret this deviation as a liquidity effect and develop a new liquidity measure quantifying the price dispersion in the context of the US corporate bond market. This market offers a unique opportunity to study liquidity effects since, from October 2004 onwards, all OTC transactions in this market have to be reported to a common database known as the Trade Reporting and Compliance Engine (TRACE). Furthermore, market-wide average price quotes are available from Markit Group Limited, a financial information provider. Thus, it is possible, for the first time, to directly observe deviations between transaction prices and the expected market valuation of securities. We quantify and analyze our new liquidity measure for this market and find significant price dispersion effects that cannot be simply captured by bid-ask spreads. We show that our new measure is indeed related to liquidity by regressing it on commonly-used liquidity proxies and find a strong relation between our proposed liquidity measure and bond characteristics, as well as trading activity variables. Furthermore, we evaluate the reliability of end-of-day marks that traders use to value their positions. Our evidence suggests that the price deviations from expected market valuations are significantly larger and more volatile than previously assumed. Overall, the results presented here improve our understanding of the drivers of liquidity and are important for many applications in OTC markets, in general.     

投资者注意力、应计误定价与盈余操纵

基于应计误定价视角,以投资者认知特征分析为切入点,本文检验了投资者注意力、应计误定价及盈余操纵间的关系。研究发现:(1)投资者注意力具有认知效应,投资者注意力的提高能够显著提高其对盈余构成信息的认知效率,并降低市场中投资者对应计信息的定价高估;(2)投资者注意力具有治理效应,即投资者对股票的充分注意能够显著降低管理层主观的盈余操纵行为。综合而言,投资者注意力具有"认知效应"和"治理效应",投资者注意力调节了投资者的认知效率并提升了对会计盈余构成信息的定价效率,进一步影响了管理层主观的盈余操纵行为。深化投资者注意力的研究具有很高的理论价值和现实意义。     

Market reaction to and valuation of IFRS reconciliation adjustments: first evidence from the UK

We investigate the market reaction to, and the value-relevance of, information contained in the mandatory transitional documents required by International Financial Reporting Standards 1 (2005). We find significant negative abnormal returns for firms reporting negative earnings reconciliation. Although the informational content of the positive earnings adjustments is value-relevant before disclosure, for negative earnings adjustments it is value-relevant only after disclosure. This finding is consistent with managers delaying the communication of bad news until IFRS compliance. A finer model shows that adjustments attributed to impairment of goodwill, share-based payments, and deferred taxes are incrementally value-relevant but that only the impairment of goodwill and deferred taxes reveal new information. Our results indicate that mandatory IFRS adoption alters investors’ beliefs about stock prices.     

Economic determinants of price informativeness about future earnings

This study investigates how the value-creation process affects the extent to which stock prices incorporate value-relevant information about future earnings. In contrast to previous studies focusing on the value-reporting process, this paper shows that strong product market power accelerates the incorporation of future earnings into current equity prices due to less uncertainty about future cash flows and that intensive long-term investment deters such incorporation because of greater uncertainty regarding future cash flows. The results suggest that firm fundamentals shaped by product market competition and long-term investment explain the price informativeness about future earnings beyond the impact of management’s reporting discretion.     

The “make or take” decision in an electronic market: Evidence on the evolution of liquidity

This paper uses experimental asset markets to investigate the evolution of liquidity in an electronic limit order market. Our market setting includes salient features of electronic limit order markets, as well as informed traders and liquidity traders. We focus on the strategies of the traders and how these are affected by trader type, characteristics of the market, and characteristics of the asset. We find that informed traders use more limit orders than do liquidity traders. Our main result is that liquidity provision shifts as trading progresses, with informed traders increasingly providing liquidity in markets. The change in the behavior of the informed traders seems to be in response to the dynamic adjustment of prices to information; they take (provide) liquidity when the value of their information is high (low). Thus, a market-making role emerges endogenously in our electronic markets and is ultimately adopted by the traders who are least subject to adverse selection when placing limit orders.     

Institutional investor sentiment and aggregate stock returns

This paper examines the equity market return predictability of institutional investor sentiment, in comparison to individual investor sentiment. Our findings suggest that institutional traders are informed and that their sentiment helps to tilt stock prices towards the intrinsic value. This is because the sentiment of institutions encompasses news regarding expectations on future cash flows of underlying firms that impounds itself into future price expectations. In this study, we add to the large number of studies that investigate the role and implications of investor sentiment, which has long been viewed as a pure behavioural phenomenon, on market efficiency and price discovery.     

Can Miracles Lead to Crises? The Role of Optimism in Emerging Markets Crises

Emerging market financial crises are abrupt and dramatic usually occurring after a precrisis bonanza. This paper develops an equilibrium asset pricing model with informational frictions in which crisis itself is a  consequence  of the investor optimism in the period preceding the crisis. If preceded by a sequence of positive signals, a small, negative noise shock can trigger a downward adjustment in investors' beliefs, asset prices, and consumption. The magnitude of this downward adjustment  increases  with the level of optimism attained prior to the negative signal. Moreover, with informational frictions, asset prices display persistent effects in response to transitory shocks.     

Earnings characteristics and analysts’ differential interpretation of earnings announcements: An empirical analysis

This study provides empirical evidence on factors that drive differential interpretation of earnings announcements. We document that Kandel and Pearson's forecast measures of differential interpretation are decreasing in proxies for earnings quality and pre‐announcement information quality. This evidence yields new and useful insights regarding which earnings announcements are less likely to generate newfound disagreement among analysts and investors. Recent research suggests that investor disagreement can increase investment risk, increase the cost of capital, and cause stock prices to deviate from fundamental value. Therefore, our results support prior intuition that increasing the quality of earnings and pre‐announcement information can improve the efficiency of capital markets.     

Learning from others,reacting, and market quality

Traders pay attention to one another but are unable to perfectly deduce each others’ beliefs from transactions alone. This explains why markets are hard to beat and also why trading occurs at all. Even when traders react rationally to the actions of others, they cannot arrive easily at a common posterior assessment of value. We model a realistic market composed of traders who combine their own private information with rational learning about the information possessed by others. We compare phenomena in this market with an otherwise identical market populated by traders who receive the same private information but ignore other traders. Using simulation to engender greater realism, we find that learning usually reduces volatility, increases the accuracy of the market price as a forecast of value, reduces trading volume, and decreases the prevalence of bubbles. However, for some combinations of market conditions, learning can have the opposite effect. The marginal influences of eight different market conditions, ranging from information heterogeneity through resource diversity, are estimated. Prices, volatility, volume, and bubbles exhibit subtle and complex responses to market conditions.