Information Asymmetry and Cross-Sectional Returns: A Re-Examination of the Relationship between Stock Return and the Adjusted Probability of Informed Trading

Abstract

We re-examine the relationship between stock return and the adjusted probability of informed trading (AdjPIN) for about 40,000 firm-years of NYSE/AMEX listed firms. We obtain two AdjPIN estimates for each firm-year pair: the first is estimated with all daily observations in the year, while the second is estimated after excluding 20 daily observations around each earnings announcement date. On average, the second estimate is greater than the first one. The difference between these two estimates is significantly smaller for firms that have large market capitalization or are actively traded. With both sets of estimates, the Fama-MacBeth regression analysis shows a significant and positive relationship between stock return and AdjPIN in the period between 1984 and 2005. Our findings support that information asymmetry in itself plays a role in explaining the cross-section of stock returns, though its effect appears to vary across time periods.

Keywords: Adjusted PIN, Earnings announcements, Information asymmetry, Probability of informed trading

JEL Classification: C13, C61, G12, G14