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Asymmetric Effects of Informed Trading on the Cost of Equity Capital

Author

Listed:
  • Michael J. Brennan

    (Anderson School of Management, University of California, Los Angeles, Los Angeles, California 90095; and Manchester Business School, University of Manchester, Manchester M13 9PL, United Kingdom)

  • Sahn-Wook Huh

    (School of Management, University (SUNY) at Buffalo, Buffalo, New York 14260)

  • Avanidhar Subrahmanyam

    (Anderson School of Management, University of California, Los Angeles, Los Angeles, California 90095)

Abstract
We decompose PIN, the probability of informed trading, into good-news (PIN_G) and bad-news (PIN_B) components, which we estimate at a quarterly frequency. We first assess the validity of PIN as a measure of informed trading by calculating its association with measures of the adverse-selection component of the cost of trading. We then provide new evidence that PIN_G and PIN_B capture informed trading around earnings announcements by showing that they predict positive and negative earnings surprises, respectively. Conjecturing that investors who take long positions will be more concerned about informed selling than about informed buying since the former depresses the sale price whereas the latter raises it, we then investigate asymmetry in the pricing of private information. We find strong evidence of such asymmetry in that the effect of PIN_B on the cost of equity capital is large and highly significant, whereas the effect of PIN_G is small and statistically insignificant.Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2015.2250 . This paper was accepted by Neng Wang, finance .

Suggested Citation

  • Michael J. Brennan & Sahn-Wook Huh & Avanidhar Subrahmanyam, 2016. "Asymmetric Effects of Informed Trading on the Cost of Equity Capital," Management Science, INFORMS, vol. 62(9), pages 2460-2480, September.
    • Handle: RePEc:inm:ormnsc:v:62:y:2016:i:9:p:2460-2480
    DOI: 10.1287/mnsc.2015.2250
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    8. Man Jin & Shunan Zhao & Subal C. Kumbhakar, 2020. "Information asymmetry and leverage adjustments: a semiparametric varying‐coefficient approach," Journal of the Royal Statistical Society Series A, Royal Statistical Society, vol. 183(2), pages 581-605, February.
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