Private Information Flow Research Articles

A Solution to the Closed-End Fund Puzzle Without Market Frictions and Arbitrage

We present a solution to the Closed-End Fund Puzzle in frictionless and arbitrage-free financial markets. This solution can explain both the time-series and the cross-sectional aspect of the Closed-End Fund Puzzle in a model-independent framework. The main result can be stated as follows: If the market is arbitrage free with respect to the flow of information used by the fund manager, the fund can never trade at a premium and there is no discount if and only if the fund manager applies a maximal strategy. We conjecture that most fund managers do not apply a maximal strategy. This means discounts are a natural phenomenon in an arbitrage-free financial market. Our result does not rule out the existence of premia. Nonetheless, a premium always indicates that the market is inefficient with respect to the information flow that is used by the fund manager. For example, the market could be arbitrage free with respect to the flow of public information while, at the same time, some flow of private information provides an arbitrage opportunity. In this case the fund manager has to make use of private information to realize a premium.

S&P 500 Membership and Managerss Supply of Conservative Financial Reports

Our study is motivated by economic theory and the debate among practitioners, standard setters, and academics on the role of conditional conservatism in financial reporting. We find that managers provide less conditionally conservative financial reports after their firms are added to the Standard and Poor’s (S&P) 500 index. S&P 500 membership is expected to reduce information asymmetry between managers and outside stakeholders due to an increased flow of public and private information. As a result, the contracting benefits of conservative accounting choices are reduced, and managers are less willing to provide conditionally conservative reports. In contrast, we find that managers provide more conditionally conservative financial reports after their firms are deleted from the index. Firms being deleted from the S&P 500 index likely incur an increase in information asymmetry. Overall, our results provide evidence consistent with conditional conservatism being a response by managers to the information needs of financial statements users.

Market Liquidity, Private Information, and the Cost of Capital: Microstructure Studies on Family Firms in Japan

We investigate market liquidity, distribution of private information-based trades, and the cost of capital of publicly traded family firms in Japan. First, we find that family firms in Japan have a lower cost of debt, lower market liquidity, and higher information asymmetry. However, we did not find any difference in the cost of equity, although it is slightly higher for family firms. Accordingly, the WACC of family firms is higher than that for non-family firms although it is significant only for the conventional t-test. As for estimation of information asymmetry and illiquidity, we use the private information flow (Adjusted PIN) and the symmetric order inflow shock (PSOS). In addition, we estimate several conventional measures of market liquidity and illiquidity as used in microstructure studies. We find that the PSOS is a good measure of market illiquidity for our sample of family firms and control non-family firms. In conclusion, we claim that more voluntary disclosure is called for among Japanese family firms; first, to decrease the cost of equity, and second, to increase market liquidity of traded stocks as well as reduce the probability of private information-based trades. This is the first study to use asymmetric information related variables in family business research, which is a new contribution to the literature.

DEFF: a new architecture for private online social networks

ABSTRACTIn recent years, online social networks (OSNs) have had explosive growth in numbers and popularity. In an OSN, users communicate with each other and share information about themselves. However, limiting the flow of private information across OSNs is very important especially because most OSNs provide insufficient privacy settings to control information leakage. In this paper, we propose a mediated architecture for OSNs that protects users' information from both the OSN provider and unauthorized OSN users. Our proposed approach delegates most of the computation tasks to a semi‐trusted proxy server. We exploit a simplified broadcast encryption method in order to design a dynamic, efficient, flexible, and fine‐grained (DEFF) control system. In the proposed DEFF system, users are allowed to cryptographically categorize their friends into different relations and to share data with arbitrary groups of them. The results of our analysis indicate that the DEFF system fully protects users' privacy and is very efficient in terms of communication and computation complexities. Copyright © 2012 John Wiley & Sons, Ltd.

Reporting Timeliness, Private Information and Stock Price Synchronicity Morck et al. (2000) Revisited

Morck et al. (2000) argue that lack of private property protection discourages informed traders from capitalizing on firm private information which incorporates more market risk in stock returns. This paper extends Morck et al. (2000) investigations and suggests alternatively that firm corporate transparency namely frequent reporting motivates private information flow into stock prices. It also suggests that private property protection is associated with less market risk noise and not more firm-specific information. These results are consistent with Jin and Myers (2006) who suggest that insiders in opaque firms are reluctant to release firm information during normal and momentum earnings leading to more systematic risk in share prices. The findings suggest that firm timely reporting convey relevant expected cash flow information that motivates risk arbitrageurs to trade on firm private information and incorporate more firm-specific information into stock returns.

Price Discovery and Dissemination of Private Information by Loan Syndicate Participants

ABSTRACTWe delineate key channels through which flows of confidential information to loan syndicate participants impact the dynamics of information arrival in prices. We isolate the timing of private information flows by estimating the speed of price discovery over quarterly earnings cycles in both secondary syndicated loan and equity markets. We identify borrowers disseminating private information to lenders relatively early in the cycle with firms exhibiting relatively early price discovery in the secondary loan market, documenting that price discovery is faster for loans subject to financial covenants, particularly earnings‐based covenants; for borrowers who experience covenant violations; for borrowers with high credit risk; and for loans syndicated by relationship‐based lenders or highly reputable lead arrangers. We then ask whether early access to private information in the loan market accelerates the speed of information arrival in stock prices. We document that the stock returns of firms identified with earlier private information dissemination to lenders indeed exhibit faster price discovery in the stock market, but only when institutional investors are involved in the firm's syndicated loans. Further, the positive relation between institutional lending and the speed of stock price discovery is more pronounced in relatively weak public disclosure environments. These results are consistent with institutional lenders systematically exploiting confidential syndicate information via trading in the equity market.

Market Segmentation and Informational Efficiency: Evidence from Sovereign Credit Default Swap Markets

Credit default swap markets are argued to be more informative about credit risk than corresponding bond markets due to their advantages in leverage, liquidity and ease of short selling. However, using data from emerging economies with the most liquid sovereign CDS markets, we find that sovereign CDS markets do not lead the sovereign bond market during periods with high country-specific risk, even though they do lead in other periods. Further, the flow of private information from the CDS markets to the bond markets slows or stops when country risk arises. These findings are in sharp contrast to those of Blanco, Brennan and Marsh (2005) and Acharya and Johnson (2007) on corporate CDS markets. We argue that market segmentation, which is caused by the limited access to the CDS markets for potentially informed local investors; hinder the price discovery process in the CDS markets. The trading activities of U.S. institutional investors are not inconsistent with the existence of the informed local investors during the high country risk periods. Our results suggest that policy changes on leveling the grounds for credit investors can potentially enhance the informational efficiency of the CDS markets.

Corporate Governance, Idiosyncratic Risk, and Information Flow

ABSTRACTWe study the relationship of corporate governance policy and idiosyncratic risk. Firms with fewer antitakeover provisions display higher levels of idiosyncratic risk, trading activity, private information flow, and information about future earnings in stock prices. Trading interest by institutions, especially those active in merger arbitrage, strengthens the relationship of governance to idiosyncratic risk. Our results indicate that openness to the market for corporate control leads to more informative stock prices by encouraging collection of and trading on private information. Consistent with an information‐flow interpretation, the component of volatility unrelated to governance is associated with the efficiency of corporate investment.

Re-examining the effects of regulation fair disclosure using foreign listed firms to control for concurrent shocks

We re-examine the effects of regulation fair disclosure (Reg FD) using ADRs (who are exempt from Reg FD) to control for confounding events which affected all traded firms. Tests based on public information metrics (returns volatility, informational efficiency and trading volume) and on analyst information metrics (forecast dispersion and accuracy) suggest that Reg FD did not uniquely affect the US information environment. However, analyst report informativeness declined for US firms relative to ADR firms, providing evidence consistent with Reg FD achieving one of its objectives–reducing private information flows to analysts.

Strategic Trading with Market Closures

This paper analyzes the equilibrium trading strategies of informed traders in the presence of market closures defined as periodic predictable stops of trading. We construct a dynamic auction model based on rational strategic behavior with asymmetric information across the agents. Empirical evidence indicates that market closures have important impact on the information structure of financial markets, in particular the private information flow. In our model, the insiders repeatedly increase their informational advantage over other agents by receiving private signals about fundamentals when the market is closed. In a continuous-time setting, we solve a dynamic programming problem and derive closed-form solutions for optimal intertemporal strategies of both insiders and the market maker. The key feature of insiders' optimal strategy is that they act strategically by anticipating future market closures. Because of this, even though market closures are periodic, the intertemporal pattern of optimal trading strategies is {not} periodic. This aperiodicity of trading is quite important since while it is a definitive feature of the data, it has been missing from the existing theoretical literature on market closures. In agreement with broad empirical evidence, we obtain a U-shaped pattern of trading volume during the periods when the market is open, superimposed on a U-shaped pattern during the lifetime of the economy, before all information about the asset is revealed.

Corporate Governance, Idiosyncratic Risk, and Information Flow

We study the relationship of corporate governance policy and idiosyncratic risk in stock returns. Firms with fewer anti-takeover provisions display higher levels of idiosyncratic risk, trading activity, private information flow, and more information about future earnings in stock prices. Trading interest by institutions, especially those active in merger arbitrage, strengthens the relationship of governance to idiosyncratic risk. Our results indicate that openness to the market for corporate control leads to more informative stock prices by encouraging collection of and trading on private information. Consistent with an information-flow interpretation, the component of volatility unrelated to governance is associated with the efficiency of corporate investment.

Return-Volume Dependence and Extremes in International Equity Markets

This paper reconsiders return-volume dependence for the U.S. and six international equity markets. We contribute to previous work by proposing surprise volume as a new proxy for private information flow and apply extreme value theory in studying dependence for large volume and return, i.e. under situations of market stress. Results from a GARCH-M model indicate that surprise volume is superior in explaining conditional variance and reveals a positive market risk premium. Under conditions of market stress, the return-volume dependence is weaker, albeit mostly significant. The results for the U.S. market are most pronounced in that surprise volume explains ARCH- as well as leverage-effects and, under market stress, the return-volume dependence remains significant and symmetric. For the European and Asian markets, however, the dependence is weaker with asymmetry under market stress, i.e. small minimal returns show lower volume dependence than large maximal returns. We argue that our results are more consistent with a Gennotte and Leland (1990) misinterpretation hypothesis for market crashes than with cascade or behavioral explanations which associate high volume with steep price declines.

Price discovery and the international flow of information

We document that the opening volatility of American depositary receipts (ADRs) is lower when the trading of the underlying asset overlaps trading of the ADR on the New York Stock Exchange (NYSE). This lower volatility is consistent with the notion that price discovery on the NYSE is enhanced by concurrent trading in the underlying market. We also find that ADR volatility does not change when the underlying market closes, indicating that there is no significant change in the flow of public and private information at that time. This finding suggests that the NYSE becomes the dominant market during periods when both ADRs and their underlying assets are traded.

Dynamic price formation in a futures market via double auctions

We report an exploratory study of the process of price formation in a speculative market in the absence of liquidity traders. Traders exchange a futures contract because they interpret information differently. We formulate trading as a sequence of anonymous double auctions and introduce a notion of bounded rationality in which traders use approximate models of market response in forming their bids. We prove existence of a perfect equilibrium in the sequential anonymous auctions game, and show that the equilibrium has a “no-regret” property. After learning the market price, a trader regrets neither the bid that he made nor the position that he holds. We show that trading volume is related to changes in the distribution of information in the economy. We also show that volume and expected change in price are related to two different attributes of the pattern of private information flow. Fundamentally, no particular relationship between the time series of these variables is always valid for all futures contracts. This point is emphasized by an example.

Public Information Flows in Rural Australia

Geographical studies of the transmission of information have focussed overwhelmingly on private information flows based on direct, face-to-face contact. Very little attention has been directed to media-based public information flows despite the potential importance of this type of flow in regional development. Yet an examination of newspaper content for the New England region of New South Wales for 1971 and 1977 reveals that major changes are occurring in newspaper-based information flows. Rural newspapers are becoming increasingly aspatial and parochial in their news coverage and the flow of information between rural centres is changing from a complex system to a less complex system. The reasons for these trends are not entirely clear, but may relate to economic and technological changes within the newspaper publishing industry as well as to the fortunes of regional policy in Australia.