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Who underreacts to cash-flow news? evidence from trading between individuals and institutions

  • Cohen, Randolph B.
  • Gompers, Paul A.
  • Vuolteenaho, Tuomo

A large body of literature suggests that firm-level stock prices 'underreact' to news about future cash flows, i.e., shocks to a firm's expected cash flows are positively correlated with shocks to expected returns on its stock. We estimate a vector autoregession to examine the joint behavior of returns, cash-flow news, and trading between individuals and institutions. Our main finding is that institutions buy shares from individuals in response to good cash-flow news, thus exploiting the underreaction phenomenon. Institutions are not simply following price momentum strategies: When price goes up in the absence of positive cash-flow news, institutions sell shares to individuals. Although institutions are trading in the 'right' direction, institutions as a group outperform individuals by only 1.44 percent per annum before transaction and other costs, because they are extremely conservative in deviating from the value-weight market index.

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

Volume (Year): 66 (2002)
Issue (Month): 2-3 ()
Pages: 409-462

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Handle: RePEc:eee:jfinec:v:66:y:2002:i:2-3:p:409-462
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505576

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