Information Asymmetry, Investors Trading Behavior And Asset Pricing

The Capital Asset Pricing Model(CAPM)assumes that investors have homogeneous beliefs about return and risk for risky assets and thus there is no information asymmetry.Since 1980 s,however,many papers proposed asset pricing model based on information asymmetry(Grossman and stiglitz(1980),Wang(1993),Easley and O’Hara(2004)),and verified the effect of informed trading on stock prices(Hasbrouck(1991),Llorente et al.(2002)).These papers,based on rational expectation equilibrium,systematically investigated how information asymmetry affect stock prices.Nevertheless,these models can’t be reconciled with some phenomenal market anomalies found by literature,such as post-earnings-announcement drift,momentum effect,etc.On the other hand,recent papers in behavioral finance explained these market anomalies based on the hypothesis that investors sometimes are irrational.One of the most important finding is that investors,especially individual investors,have difficulties in analyzing all available information,and have limited attentions,which make them under-react to news(Barber and Odean(2008),DellaVigna and Pollet(2009),Hirshleifer and Teoh(2005),Hirshleifer et al.(2009),Seasholes and Wu(2007)).These two fields explain market behavior of price and volume,and investorss trading behavior in two different ways,but few papers have combined these two kinds of perspective together as investors could exhibit both rational and irrational behaviors.In recent years,the development of institutional investors makes the participants in Chinese stock market more various.Also,it makes the stock prices and trading volume condition on more and more underlying factors.As there is huge information asymmetry between institutional investors and individual investors,and there are many irrational behaviors among individual investors,this paper,based on information asymmetry and irrational behaviors of individual investorss,theoretically and empirically examines the effect of asymmetry on market and on investors trading behaviors.The results of this paper are as follows.Firstly,using order money flow data from 2010 to June 2015,this paper investigates trading behaviors among different investors,and price discovery and price forecasting of investors trading behaviors.We show that institutional investors are reversal traders while individual investors are momentum traders.In the meantime,institutional investors have significant price discovery effect and price forecasting effect.Moreover,we use Vector Autogressive Regression model and Granger Causalisty test to examine two-way relationship between order flow and stock returns.We show that there is a significant two-way causality between order flow and stock returns.Lastly,in robustness check we show that price discovery and forecasting effect of institutional investors are consistently significant in both sub-period which have different market characteristics.Secondly,inspired by the empirical results of PEAD pattern in Chinese stock market,this paper constructs a theoretical model.The model takes into account information asymmetry,limited attention of individual investors and short-sale constraints.The model derives a series of testable implications and this paper empirically verified these implications.First,this paper shows that there is preearnings-announcement drift and the drift is proportional to Standardized Unexpected Earnings(SUE).Second,institutional investors net buy high SUE stocks before announcement and net sell low SUE stocks before announcement.And individual investors trade in the opposite way.On announcement day,institutional investors net sell stocks,regardless the SUE.Besides,the larger the SUE,the more amounts of stock they will sell.And individual investors trade in the opposite way.Moreover,due to the price discovery by institutional investors trading,price will drop on announcement day.In the meantime,trading volume on announcement day is proportional to SUE.In addition,this papers shows that the prices of unshortable stocks are higher than those of shortable stocks before announcement and only stocks with extreme SUE will be significantly shorted.Thirdly,we estimates daily P&L using money flow data for different investors.The results show that institutional investors in general earn much higher returns over risks,as measured by Sharpe Ratio,than market,and individual investors earn much lower Sharpe Ratio than market and they lose money during the whole sample period.Thus,based on the difference in Sharpe Ratio of different investors we construct a measure of information asymmetry and shows that information asymmetry is priced in Chinese stock market,and especially in small stocks.Also tested is another information asymmetry measure based on eranings information.We show that such measure also has significant asset pricing effect and it’s also more significant in small stocks.Lastly,we show that when putting both measures of information asymmetry into the regression,the two measures both exhibit significant pricing effect.In sum,information asymmetry has strong asset pring effect in Chinese stock market.Finally,using high frequency data of Chinese stock market in 2014,we first examines the high frequency characteristics of Chinese stock market.This paper also examines the predictability of high frequency return,and shows that order book imbalance,along with past return,past money flow and past signed squared root of volume,can predict forward one-minute return.Lastly,this paper,based on existing method to derive information content in high frequency trading,connects high frequency information asymmetry with low frequency information asymmetry as measure by AIV.The results illustrates that information asymmetry in low frequency is reflected by high frequency information asymmetry.