Local Investors, Price Discovery and Market Efficiency

Posted: 20 Apr 2010 Last revised: 6 Dec 2011

Sophie Shive

University of Notre Dame - Department of Finance

Date Written: May 9, 2011


This study examines the effect of locally informed investors on market efficiency and stock prices using large power outages, which are exogenous events that constrain trading. Turnover in stocks headquartered in a outage area with 0.5% of U.S. electrical customers drops by 3-7% on the first full day of the outage, and bid-ask spreads narrow by 2.5%. Firm-specific price volatility is 2.3% lower on blackout dates. This effect is larger for smaller, lesser-known stocks and in higher income areas. Consistent with a valuation discount and higher expected returns for stocks with more informed traders, firms with a one standard deviation higher local trading propensity have market-to-book values that are 5% lower, Tobin's Q that is 6% lower, annualized 4-factor alphas are 1.2 percent higher, and average spreads that are 6.5% higher. Together, the evidence suggests that informed investors contribute disproportionately to both liquidity and price discovery, and that these contributions are reflected in valuations and expected returns.

Keywords: local investors, price discovery, market efficiency

Suggested Citation

Shive, Sophie, Local Investors, Price Discovery and Market Efficiency (May 9, 2011). Available at SSRN: https://ssrn.com/abstract=1592675

Sophie Shive (Contact Author)

University of Notre Dame - Department of Finance ( email )

P.O. Box 399
Notre Dame, IN 46556-0399
United States

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