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Who Underreacts to Cash-Flow News? Evidence from Trading between Individuals and Institutions

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

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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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8793.

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Date of creation: Feb 2002
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Publication status: published as Cohen, Randolph B., Paul A. Gompers and Tuomo Vuolteenaho. "Who Underreacts To Cash-Flow News? Evidence From Trading Between Individuals And Institutions," Journal of Financial Economics, 2002, v66(2-3,Nov-Dec), 409-462.
Handle: RePEc:nbr:nberwo:8793
Note: AP CF
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