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Do Stock Prices Underreact to Information Conveyed by Investors' Trades? Evidence from China

Authors


  • Acknowledgments: Fei Wu was supported by the National Natural Science Foundation of China (Grant No.71072083 and 71003012) and the Jiangxi University of Finance and Economics's Innovative Research Team Development Grant. All remaining errors are our own responsibility.

Corresponding author: Fei Wu, International Institute for Financial Studies and RCFMRP, Jiangxi University of Finance and Economics, Nanchang 330013, Jiangxi, China. Tel: +86 (0) 791 8381-6750, Fax: +86 (0)791 8380-2306, email: wufei42555@gmail.com.

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.

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