India Economy

Informed trading

D. MURALI | Updated on November 15, 2017


The high trading volume observed in financial markets “is perhaps the single most embarrassing fact to the standard finance paradigm.” With this sombre thought of DeBondt and Thaler (1995) opens ‘‘How (Un)Informed Is Trading?'' by Eric K. Kelley and Paul C. Tetlock ( The authors note that stock prices respond immediately to news, while trading volume typically responds with a delay. News not only releases intractable information, which is priced immediately, but it also triggers trader attention for an extended period of time, they add. “During this window, uninformed traders choose to enter the market when it is cheapest to trade — usually in regular trading hours — regardless of when news arrives.”

Some of the key data-points cited in the paper are that in the US over 95 per cent of trading occurs during regular market hours (9:30 am to 4 pm), even though prices exhibit considerable volatility during extended hours, especially when news arrives; and that from 2001 to 2010, informed trading increasingly contributes to volume and stock price discovery because the cost of acquiring private information has fallen by a factor of 12 in this decade.

They inform that in 2001 to 2005, private information revealed through trading explains just 8 per cent of the variance in returns during the regular market, whereas it explains 76 per cent of variance from 2006 to 2010. Valuable insights.

Prominent disclosure

When a communication contains items of varying significance, making an item prominent conveys to the receiver of the message that the item is important.

This may seem to be a commonplace statement, but the worrying aspect is that the exact role of prominence in disclosures has not been well articulated, as Mark Penno and Jack Stecher highlight in “A Theory of ‘Prominent' Disclosure'' ( For instance, “Accounting disclosures apply the convention in a number of ways: When an item has been assigned to main statements (versus the footnotes); when an item is reported above the line (versus below the line) on an income statement; when an item is classified as an unusual item (versus an ordinary item); or when the firm uses different public outlets (of varying prominence) to disclose its information.”

The authors examine a setting where, when permitted some classification discretion (for example, wiggle room), the firm will choose that classification which maximises its market value. Among the many studies quoted in the paper is the one by Kothari, Shu and Wysocki (2009) who find evidence that the market reaction to bad news is stronger than the reaction to good news.

“They suggest that for a range of incentives (for example, career concerns), firms will withhold bad information until the cumulative effect on market value reaches a threshold, at which point it is released. In contrast, they suggest that firms ‘leak' good news on a more frequent basis…”

Suggested study.

Published on May 26, 2012

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