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

Randolph B. Cohen, Paul Gompers and Tuomo Vuolteenaho

No 8793, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: 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.

JEL-codes: G12 G14 (search for similar items in EconPapers)
Date: 2002-02
New Economics Papers: this item is included in nep-fmk
Note: AP CF
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Citations: View citations in EconPapers (179)

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.

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