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Informed contrarian trades and stock returns

Sanders Chang () and F. Albert Wang

Journal of Financial Markets, 2019, vol. 42, issue C, 75-93

Abstract: We develop a novel measure for the probability of informed trading. This measure, termed PCM, captures the adverse selection component of bid-ask spreads, becomes elevated around earnings announcements, and exhibits similar time-series patterns to price impact. Returns in double-sorted portfolios increase in PCM while controlling for liquidity. A long-short portfolio based on PCM generates 18.3% abnormal return annually. PCM significantly explains cross-sectional returns while controlling for other factors. This effect is robust to alternative specifications and remains significant after the decimalization in 2001. In sum, PCM is easy to implement and serves as an effective proxy for informed trading.

Keywords: Information asymmetry; Contrarian trading; Stock returns (search for similar items in EconPapers)
JEL-codes: G10 G14 G19 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (4)

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DOI: 10.1016/j.finmar.2018.08.002

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