Who Underreacts to Cash-Flow News ? Evidence from Trading between Individuals and Institutions †

A large body of literature suggests that firm-level stock prices “underreact” to news about future cash flows. We estimate a vector autoregession to examine the joint behavior of returns, cash-flow news, and trading between individuals and institutions. Our main finding is that institutions buy shares from individuals in response to good cash-flow news, thus exploiting the underreaction phenomenon. Institutions are not simply following price momentum strategies: When price goes up in the absence of positive cashflow news, institutions sell shares to individuals. The response of institutional ownership to cash-flow news is weaker for small stocks. Since small stocks also exhibit the strongest underreaction patterns, this finding is consistent with institutions facing exogenous constraints in trading small stocks.

[1]  F. Black,et al.  The Capital Asset Pricing Model: Some Empirical Tests , 2006 .

[2]  Chenchuramaiah T. Bathala.  The Investment Behavior and Performance of Various Investor Types: A Study of Finland's Unique Data Set , 2000 .

[3]  Mark Grinblatt,et al.  What Makes Investors Trade? , 2000 .

[4]  John R. Nofsinger,et al.  Herding and Feedback Trading by Institutional and Individual Investors , 1999 .

[5]  Tuomo Vuolteenaho.  What Drives Firm-Level Stock Returns? , 1999 .

[6]  Stephen E. Wilcox.  Investor Psychology and Security Market Under- and Overreactions , 1999 .

[7]  Tuomo Vuolteenaho,et al.  Understanding the Aggregate Book-to-Market Ratio , 1999 .

[8]  R. Wermers,et al.  Mutual Fund Herding and the Impact on Stock Prices , 1998 .

[9]  Paul A. Gompers,et al.  Institutional Investors and Equity Prices , 1998 .

[10]  Terence Lim,et al.  Bad News Travels Slowly: Size, Analyst Coverage and the Profitability of Momentum Strategies , 1998 .

[11]  Kent D. Daniel,et al.  Measuring mutual fund performance with characteristic-based benchmarks , 1997 .

[12]  Tyler Shumway.  The Delisting Bias in CRSP Data , 1997 .

[13]  E. Fama.  Market Efficiency, Long-Term Returns, and Behavioral Finance , 1997 .

[14]  N. Barberis,et al.  A Model of Investor Sentiment , 1997 .

[15]  R. Haugen,et al.  Commonality in the Determinants of Expected Stock Returns , 1996 .

[16]  Eric G. Falkenstein,et al.  Preferences for Stock Characteristics As Revealed by Mutual Fund Portfolio Holdings , 1996 .

[17]  S. Titman,et al.  Momentum Investment Strategies, Portfolio Performance, and Herding: A Study of Mutual Fund Behavior , 1994 .

[18]  Roni Michaely,et al.  Price Reactions to Dividend Initiations and Omissions: Overreaction or Drift? , 1994 .

[19]  J. Shao,et al.  Jackknife inference for heteroscedastic linear regression models , 1993 .

[20]  Narasimhan Jegadeesh,et al.  Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency , 1993 .

[21]  V. Bernard,et al.  Evidence that stock prices do not fully reflect the implications of current earnings for future earnings , 1990 .

[22]  L. Summers,et al.  Positive Feedback Investment Strategies and Destabilizing Rational Speculation , 1989 .

[23]  Lawrence Harris,et al.  Price and Volume Effects Associated with Changes in the S&P 500 List: New Evidence for the Existence of Price Pressures , 1986 .

[24]  Andrei Shleifer,et al.  Do Demand Curves for Stocks Slope Down , 1986 .

[25]  R. Thaler,et al.  Does the Stock Market Overreact , 1985 .

[26]  Ronald J. Lanstein,et al.  Persuasive evidence of market inefficiency , 1985 .

[27]  E. Fama,et al.  Risk, Return, and Equilibrium: Empirical Tests , 1973, Journal of Political Economy.

[28]  J. L. Bicksler,et al.  Studies in the Theory of Capital Markets. , 1973 .

[29]  M. Friedman,et al.  Essays in Positive Economics , 1954 .

[30]  J. Stein,et al.  A Unified Theory of Underreaction, Momentum Trading and Overreaction in Asset Markets , 1997 .

[31]  Diane Del Guercio.  The Distorting Effect of the Prudent-Man Laws on Institutional Equity Investments , 1996 .

[32]  W. Rogers.  Regression standard errors in clustered samples , 1994 .

[33]  Josef Lakonishok,et al.  The impact of institutional trading on stock prices * , 1991 .

[34]  Victor L. Bernard,et al.  POST-EARNINGS-ANNOUNCEMENT DRIFT - DELAYED PRICE RESPONSE OR RISK PREMIUM , 1989 .

[35]  C. Nelson,et al.  A new approach to decomposition of economic time series into permanent and transitory components with particular attention to measurement of the ‘business cycle’☆ , 1981 .

[36]  Fischer Black,et al.  How to Use Security Analysis to Improve Portfolio Selection , 1973 .