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Keywords:

  • Under-reaction;
  • Information;
  • Price impact;
  • Trading process;
  • Return predictability

Abstract

We examine the process of stock prices adjusting to information conveyed by the trading process. Using the price impact of a trade to measure its information content, we show that the weekly price impact has significant cross-sectional predictive power for returns in the subsequent week. The effect is sensitive to the level of informational asymmetry. We find that the price impact contains information that is not fully captured by public order flows and that a lead–lag effect exists regarding the arrival of information to different groups of investors. Our finding suggests a price under-reaction to trading information, which can be explained by the gradual-information-diffusion theory.