NBER: Informed Trading and Expected Returns

May 2, 2013 Leave a comment

Informed Trading and Expected Returns

Stocks with the greatest information asymmetry have annualized returns that are 10.8 percentage points higher than stocks with the least information asymmetry.

In Informed Trading and Expected Returns (NBER Working Paper No. 18680), co-authors James Choi, Li Jin, andHongjun Yan use daily institutional ownership data from the Shanghai Stock Exchange to examine whether information asymmetry affects expected stock returns. They argue that focusing on China is useful because there is likely to be significant variation across companies in how much private information is shared with select investors, largely as a result of the state of Chinese legal institutions and regulations. The authors first show that stocks bought heavily by institutions subsequently outperform stocks sold heavily by institutions. Thus, institutions appear to have a strong information advantage over individual investors, and that is true for stocks of all sizes. Moreover, the authors confirm that the institutional sector’s future information advantage is larger in stocks that it previously traded more aggressively. Therefore, the aggressiveness of institutional trading in a stock, as measured by prior institutional ownership volatility, can be used as an ex ante predictor of future information asymmetry in this stock. Sorting stocks based on this predictor of information asymmetry, the authors find that the 20 percent of stocks with the greatest information asymmetry have future annualized returns that are 10.8 percentage points higher than the 20 percent of stocks with the least information asymmetry. This difference remains significant for ten months after the initial sorting month—the same amount of time that the difference in institutional information advantage between the two portfolios lasts. There is no evidence of subsequent return reversals. They conclude that information asymmetry increases the cost of capital. –Claire Brunel

Informed Trading and Expected Returns

James J. Choi, Li Jin, Hongjun Yan

NBER Working Paper No. 18680
Issued in January 2013
Does information asymmetry affect the cross-section of expected stock returns? Using institutional ownership data from the Shanghai Stock Exchange, we show that institutions have a strong information advantage over individual investors. We then show that the aggressiveness of institutional trading in a stock—measured by the average absolute weekly change in institutional ownership during the past year—is an ex ante predictor of future information asymmetry in this stock. Sorting stocks on this information asymmetry predictor, we find that the top quintile outperforms the bottom quintile next month by 10.8% annualized, suggesting that information asymmetry raises the cost of capital.

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Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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