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Local investors, price discovery, and market efficiency

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  • Shive, Sophie
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    Abstract

    This study examines the effect of locally informed investors on market efficiency and stock prices using large power outages, which are exogenous events that constrain trading. Turnover in stocks headquartered in an outage area with 0.5% of U.S. electrical customers drops by 3–7% on the first full day of the outage, and bid–ask spreads narrow by 2.5%. Firm-specific price volatility is 2.3% lower on blackout dates. This effect is larger for smaller, lesser-known stocks and in higher income areas. Consistent with a valuation discount and higher expected returns for stocks with more informed traders, firms with a one-standard-deviation higher local trading propensity have market-to-book values that are 5% lower, Tobin's Q that is 6% lower, annualized four-factor alphas that are 1.2% higher, and average spreads that are 6.5% higher. Together, the evidence suggests that informed investors contribute disproportionately to both liquidity and price discovery, and that these contributions are reflected in valuations and expected returns.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0304405X11002662
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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Financial Economics.

    Volume (Year): 104 (2012)
    Issue (Month): 1 ()
    Pages: 145-161

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    Handle: RePEc:eee:jfinec:v:104:y:2012:i:1:p:145-161

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    Web page: http://www.elsevier.com/locate/inca/505576

    Related research

    Keywords: Local bias; Market efficiency; Adverse selection;

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    Cited by:
    1. Baltzer, Markus & Stolper, Oscar & Walter, Andreas, 2013. "Is local bias a cross-border phenomenon? Evidence from individual investors’ international asset allocation," Journal of Banking & Finance, Elsevier, vol. 37(8), pages 2823-2835.
    2. Berry, Thomas & Gamble, Keith Jacks, 2013. "Informed local trading prior to earnings announcements," Journal of Financial Markets, Elsevier, vol. 16(3), pages 505-525.

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