Abstract
This paper provides a new explanation to the gradual information diffusion puzzle from the perspective of information asymmetry. I document a strong cross-predictability of stock returns driven by institutional investors' private information about firms' fundamental relations. A value-weighted arbitrage portfolio yields a monthly alpha of 1.65%. Contrary to the limited attention hypothesis, the magnitude of predicted returns increases with firm size, number of institutional shareholders, and institutional trading intensity while not decreasing with analysts following. Further evidence confirm that institutional investors strategically trade a stock in response to shocks to its peers, which subsequently causes lagged permanent price movements.
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