Stock Price Efficiency Research Articles

High‐frequency trading from an evolutionary perspective: Financial markets as adaptive systems

AbstractThe recent rapid growth of algorithmic high‐frequency trading strategies makes it a very interesting time to revisit the long‐standing debates about the efficiency of stock prices and the best way to model the actions of market participants. To evaluate the evolution of stock price predictability at the millisecond timeframe and to examine whether it is consistent with the newly formed adaptive market hypothesis, we develop three artificial stock markets using a strongly typed genetic programming (STGP) trading algorithm. We simulate real‐life trading by applying STGP to millisecond data of the three highest capitalized stocks: Apple, Exxon Mobil, and Google and observe that profit opportunities at the millisecond time frame are better modelled through an evolutionary process involving natural selection, adaptation, learning, and dynamic evolution than by using conventional analytical techniques. We use combinations of forecasting techniques as benchmarks to demonstrate that different heuristics enable artificial traders to be ecologically rational, making adaptive decisions that combine forecasting accuracy with speed.

Interactive Distraction: The Effect of Macroeconomic News on Market Reaction to Earnings News

We show evidence that consistent with category-learning behavior, investors allocate more attention to macroeconomic news than to firm-specific news, such as earnings announcements. Despite the distracting effect of macroeconomic news on investor attention, we find that earnings announcements with concurrent macroeconomic news announcements actually have significantly stronger immediate market response and weaker post-earnings announcement drift. We hypothesize that the combined total attention to macroeconomic news and earnings announcements helps investors understand both the systematic and firm-specific components of earnings surprises. Consistent with the hypothesis, our results show that the macroeconomic news effect is mainly driven by firms with high exposure to macroeconomic news. Moreover, we show that the effect is stronger when macroeconomic news contains more information and for firms with greater information uncertainty. Finally, we provide evidence that macroeconomic news helps reduce stock return uncertainty and enhance stock price efficiency.

NYSE closure and global equity trading: The case of cross-listed stocks

Cross-listing in the US opens a new information channel for cross-listed stocks and makes the cross-listed stocks more dependent on the US market as a source of information and intermarket competition for order flow. We test this proposition by examining the effects of closures of the NYSE on trading of cross-listed stocks in their home markets. We use daily and intraday trading data for stocks from 36 countries that cross-list on the NYSE during the period 2009–2018 to estimate measures of stock liquidity and information efficiency of stock prices on normal days and on days when the NYSE is closed due to US public holidays and natural hazards. We document that, when the NYSE is closed, stocks that cross-list on the NYSE see a significant reduction in stock liquidity and information efficiency of stock prices in their home markets, over and above the reduction experienced by their domestic counterparts. In addition, we investigate several channels that could explain the documented reduction in liquidity and price efficiency - information, substitute and arbitrage channels. We document that cross-listed stocks are more affected by NYSE closure when they have greater dependence on the US market, and when arbitrage strategies are easier to implement, providing some evidence for the information channel and arbitrage channel arguments.

Sophistication of Chinese Mutual Funds and the Mispricing of Accruals

ABSTRACTThis study examines the role of mutual funds in the pricing of accruals in China's stock market to evaluate the sophistication of Chinese mutual funds. Using a sample of A-share stocks in China from 2003 to 2011, I find that the mispricing of accruals is concentrated in firms with large mutual fund holdings. This result differs from a number of U.S. studies documenting a positive relation between institutional holdings and stock price efficiency. In an effort to explain this result, I provide evidence that mutual funds in China fixate on earnings and fail to understand the one-year-ahead earnings implication of accruals. Specifically, I find that the persistence of accruals is overpriced in stocks with a high level of mutual fund ownership. The mispricing of accruals in these stocks is largely driven by discretionary accruals and is related to their high stock price responsiveness to earnings.JEL Classifications: M41; G12.

Public news announcements, short-sale restriction and informational efficiency

In this paper, we address the question that with differences in opinion in reality, how quickly stocks incorporate news shocks when they are subject to different levels of short-sale constraints. Specifically, we examine the impact of short-sale restriction on stock price efficiency when firms make public earnings announcements. Using data from the Hong Kong stock market, where some stocks are eligible for and others are prohibited from short selling, we find significantly lower post-announcement returns with high economic magnitude for short-sale prohibited stocks with both positive and negative news shocks. The reduction in informational efficiency due to short-sale restriction persists several months after the earnings announcement. The informational inefficiency due to short-sale restriction is particularly severe for firms with negative announcement period shocks and subject to greater differences in opinion.

The Loud Silence of Suppressed Short-Sale Demand

Utilizing the special institutional setting in the Chinese securities market, we examine how suppressed short-sale demand influences stock valuations and price efficiency for stocks with no short-selling activities. Based on revealed short-sale volume of shortable stocks, we employ a characteristics model to estimate the suppressed short-sale demand for non-shortable stocks, with a higher short-sale demand being suppressed indicates a more binding short-sale constraint. We find that suppressed short-sale demand negatively predicts future returns, and such relation concentrates among firms with poor information environment. Consistent with Diamond and Verrecchia (1987)’s reduced-pricing-efficiency theory, we find that a higher suppressed short-sale demand is associated with a greater price delay and a stronger post-earnings-announcement-drift.

Institutional ownership and the choice of equity issue method

We examine how institutional ownership, which reflects the informational efficiency of stock prices (Boehmer and Kelley, 2009), impacts the seasoned equity offering (SEO) issue method choice between shelf offerings and traditional SEOs. We find that firms with greater institutional ownership, particularly long term ownership, tend to choose shelf offerings. We control for issue method choice and find that the offer discount decreases with institutional ownership for both shelf and traditional issuers and that higher institutional ownership reduces direct issue costs and is related to a shorter due diligence process for traditional SEOs. This suggests that underwriters are more likely to be able to perform the certification function (and with less effort) for issuers whose stock is priced more efficiently.

Successive short‐selling ban lifts and gradual price efficiency: evidence from China

AbstractUsing a database of five successive short‐selling ban lifts in the Chinese stock market, we find that the stock price efficiency gradually changes. Specifically, the price efficiency of stocks that can be shorted later improves more than the price efficiency of stocks that can be shorted earlier. Two hypotheses are tested to explain the gradual changed price efficiency: the private information hypothesis and the analysis capability hypothesis. We further show that short selling is more associated with private information than with public information and that the relationship grows stronger after each ban lift, which supports the private information hypothesis.

Do Foreign Investors Promote Stock Price Efficiency in Emerging Markets?

AbstractThis paper examines the role of foreign investors in promoting stock price efficiency in emerging stock markets relying on the fact that stock prices in these markets are influenced by both local and global factors. We employ a data sample of Vietnamese‐listed firms on the Ho Chi Minh City stock exchange over the period from 2006 to 2015. We utilize the panel data estimation analysis. The results show that foreign investors accelerate the incorporation of available information into local stock prices. The finding reinforces the important role of foreign investors in domestic stock markets of emerging economies.

Top managerial power and stock price efficiency: Evidence from China

Using higher top managerial ownership, occurrence of CEO duality, and lower ownership of the controlling shareholder to proxy for higher top managerial power in China's A-shares, we find firms with higher top managerial power have higher stock price delay after controlling for liquidity and investor attention variables. Moreover, top managerial ownership of SOE firms exhibits a lower influence on stock price delay than top managerial ownership of non-SOE firms, suggesting top managers' promotion incentive in SOE firms has the opposite effect to their equity incentive on stock price efficiency. Furthermore, our findings show that firms with higher top managerial power component of stock price delay exhibit lower quality of accruals, spend more time to release financial reports, and have higher chances of financial misconduct and that accounting quality measures associated with top managerial power significantly explain stock price delay, indicating top managerial power influences stock price efficiency through the accounting quality channel. Finally, our evidence shows that the Split-Share Structure Reform initiated in 2005 increases the influences of both top managerial ownership and ownership of the controlling shareholder on stock price delay and suggests that the anti-corruption campaign launched in 2012 restricts financial manipulations from top managers whereas decreases the incentives of the controlling shareholder to monitor top managers.

Skewness, short interest and the efficiency of stock prices

ABSTRACTWe examine the association between return skewness, short interest and the efficiency of stock prices. Since preferences for skewness have been shown to impact asset prices, we examine how skewness relates to market efficiency. We find that stocks with positive skewness are less efficient, which might be explained by investor preferences for positive skewness. Next, we document that short interest reduces both total skewness and idiosyncratic skewness. Finally, while research has shown that short selling can improve the efficiency of markets generally, we show that short interest’s ability to improve market efficiency is strongest in stocks with the highest skewness.

Shareholder Coordination, Information Diffusion and Stock Returns

AbstractWe show that the quality of information‐sharing networks linking firms’ institutional investors has stock return predictability implications. We find that firms with high shareholder coordination experience less local comovement and less post‐earnings announcement drift, consistent with the notion that information‐sharing networks facilitate information diffusion and improve stock price efficiency. In support of the view that coordination acts as an information diffusion channel, we document that the stock return performance of firms with high shareholder coordination leads that of firms with low shareholder coordination.

Do Board Characteristics Matter to Insider Timing and Profitability in the US Market?

In this paper I analyze the relationship between insider trading and corporate governance characteristics. Despite, the widely held view that insider trading significantly affects stock prices; little is known about what causes such market inefficiency and whether firm characteristics matters. This paper focuses on the impact of board structure towards insider trading and stock price efficiency. Using an event study methodology, this paper analyzes the influence of different board characteristics on insider profits as measured by share price abnormal returns. It also uses purchase ratio as a proxy for insider trading activities. Findings suggest that higher board independence, small board size and high debt levels have a significant influence towards reducing insider profits. The trading activities of insiders appear to have no significant relationship to the corporate governance characteristics of the firm. The overall results suggest that good governance reduces insider abnormal profits and increase stock price efficiency. With regards to insider trading activities we found little evidence suggesting corporate governance impact insider trading associated with future cash-flows. The study uses a sample of 250 firms from S&P 500 Index from 2000 to 2005.

Market maker competition and price efficiency: Evidence from China

We test the relationship between market maker competition and stock price efficiency. Using the number of market makers as a proxy for competition, the results show a strong positive correlation between competition and stock price efficiency. Moreover, price efficiency is higher when competing market makers have higher research ability. We suggest that market maker competition increases price efficiency through two channels: 1) Competition decreases transaction costs, and 2) Uninformed market makers learn from orders submitted by informed market makers through competition. The latter happens only in the group of market makers with higher experiences. The results imply that the price efficiency can be improved by enhancing the competition of market makers with high research ability and experiences.

Hedge Fund Holdings and Stock Market Efficiency

We study the relation between hedge fund equity holdings and measures of informational efficiency of stock prices derived from intraday transactions as well as daily data. Our findings support the role of hedge funds as arbitrageurs who reduce mispricing in the market. Hedge funds invest in stocks that are relatively inefficiently priced, and the price efficiency of these stocks improves after hedge funds increase their holdings. Hedge fund ownership contributes more to efficient pricing than ownership by other types of institutional investors. However, stocks held by hedge funds experienced large declines in price efficiency during several liquidity crises. Received July 27, 2016; editorial decision January 07, 2017 by Editor Wayne Ferson.

Does short selling improve stock price efficiency and liquidity? Evidence from a natural experiment in China

ABSTRACTChina introduced short selling for designated stocks in March 2010. Using this important policy change as a natural experiment, we examine the effect of short selling on stock price efficiency and liquidity. We show that the introduction of short selling significantly improves price efficiency, as measured by the differences in individual stock responses to market returns and the delay in price adjustments. Short selling also enhances stock liquidity, as measured by bid-ask spread and Amihud [2002. ‘Illiquidity and Stock Returns: Cross-section and Time-series Effects.’ Journal of Financial Markets 5: 31–56] illiquidity measure; and reduces stock volatility. Overall, our results suggest that short selling helps to stabilize asset prices, provides additional liquidity and improves market quality, even in an emerging economy with a less developed stock market than that in the US and Europe.

Product Experience and Stock Price Efficiency

We show that product using experience can improve stock price efficiency. Based on U.S consumer expenditure data from 1998 to 2015, we construct a consumption-based proxy for product experience at firm level. We find that investors incorporate both industry and firm specific information into stock price more quickly when they have more experience with relevant firm’s products. This effect is stronger if more individual investors are present. Analyst coverage only enhances price efficiency for non-consumer-goods firms. These results suggest that product experience can help unsophisticated investors to develop recognition and knowledge about firms’ business and to process information more efficiently. With product experience, people may not diligently read analyst reports.

NYSE Closure and Global Equity Trading: The Case of Cross-Listed and Domestic Stocks

Cross-listing in the US opens a new information channel for cross-listed stocks and makes the cross-listed stocks more dependent on the US market as a source of information and intermarket competition for order flow. We test this proposition by examining the effects of closures of the NYSE on trading of cross-listed stocks in their home markets. We use daily and intraday trading data for stocks from 36 countries that cross-list on the NYSE during the period 2009-2018 to estimate measures of stock liquidity and information efficiency of stock prices on normal days and on days when the NYSE is closed due to US public holidays and natural hazards. We document that, when the NYSE is closed, stocks that cross-list on the NYSE see a significant reduction in stock liquidity and information efficiency of stock prices in their home markets, over and above the reduction experienced by their domestic counterparts. In addition, we investigate several channels that could explain the documented reduction in liquidity and price efficiency - information, substitute and arbitrage channels. We document that cross-listed stocks are more affected by NYSE closure when they have greater dependence on the US market, and when arbitrage strategies are easier to implement, providing some evidence for the information channel and arbitrage channel arguments.

Tweeting the Good News: Returns and Price Informativeness

Recent innovations in information technology (Social Media) have made voluntary firm disclosure ubiquitous, cheap, and timely. We study the use of Twitter, and exploit a 2013 regulatory change that makes financial tweeting credible. Consistent with theoretical models, we find that firms release mostly positive information; tweeting days are characterized by high returns not subsequently reversed. Consistent with theories of investor attention, when firms tweet negative information, they select times of low investor attention, such as Fridays or outside of market hours. Finally, tweeting is positively related to firm stock price efficiency, suggesting that firms using Twitter release valuation-relevant information sooner.

Does Herding Exist? Evidence from Pakistan’s Stock Exchange

Herding transpires when an investor imitates the decision of other stockholders or shadow market consensus (Rizzi, 2008). The Chartered Financial Analyst Institute affirms “Herding Behavior Bias” as the principal presumption influencing the investor’s decision. (Kunte, S.2015). Herding behavior contradicts the validity of an Efficient Market Hypothesis (Famma and Franch, 1970). The investigation of herd behavior in the Pakistan stock market is indispensable as the inconsistent behavior of stockholders stems from the inefficient assets pricing and resource misallocation. The study’s result affirms the existence of herd behavior in the stock exchange of Pakistan and contradicts rational assets pricing model and stock price efficiency theory.