Securities Markets in Which Some Investors Receive Information About Cash Flow Betas

Abstract

We analyze a single-factor setting in which there is private information regarding cash flows as well as their betas. Private information about betas, together with market makers’ risk aversion and mean betas’ nonnegativity, implies a nonlinear price schedule whose stochastic slope covaries positively with order flow when the expected factor payoff is positive and vice versa. We predict a negative relation between the covariance and expected returns and an attenuation of the beta anomaly in asset returns after accounting for this relation. Empirical tests confirm these predictions. This paper was accepted by Lukas Schmid, finance. Funding: L. Yang acknowledges the Social Sciences and Humanities Research Council of Canada [Grant 435-2021-0040] and Bank of Canada Fellowship for financial support. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2022.02061 .