Are Investors Naive about Incentives?
AbstractTraditional economic analysis of markets with asymmetric information assumes that uninformed agents account for the incentives of informed agents to distort information. We analyze whether investors in the stock market internalize such incentives. Stock recommendations of security analysts are likely to be biased upwards, particularly if the issuing analyst is affiliated with the underwriter of the recommended stock. Using the NYSE Trades and Quotations database, we find that large (institutional) traders account for the upward bias and exert no abnormal trade reaction to buy recommendations, and significant selling pressure in response to hold recommendations. Small (individual) traders do not account for the upward shift and exert significantly positive pressure for buys and zero pressure for hold recommendations. Moreover, large traders discount positive recommendations from affiliated analysts more than from unaffiliated analysts, while small traders do not distinguish between them. The naive trading behavior of small investors induces negative abnormal portfolio returns.
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Bibliographic InfoPaper provided by Stanford University, Graduate School of Business in its series Research Papers with number 1867.
Date of creation: Sep 2004
Date of revision:
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Postal: Stanford University, Stanford, CA 94305-5015
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Other versions of this item:
- D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
- D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
- G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
- G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
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