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

45 Pages Posted: 25 May 2001

See all articles by Randolph B. Cohen

Randolph B. Cohen

Harvard Business School - Finance Unit

Paul A. Gompers

Harvard Business School - Finance Unit; Harvard University - Entrepreneurial Management Unit; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Tuomo Vuolteenaho

Arrowstreet Capital, LP; National Bureau of Economic Research (NBER)

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Abstract

A large body of literature suggests that firm-level stock prices "underreact" to news about future cash flows. 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. The response of institutional ownership to cash-flow news is weaker for small stocks. Since small stocks also exhibit the strongest underreaction patterns, this finding is consistent with institutions facing exogenous constraints in trading small stocks.

Keywords: Underreaction, Overreaction, Cash-flow news, Expected returns, Individuals, Institutions, Trading

JEL Classification: G12, G14, M41

Suggested Citation

Cohen, Randolph B. and Gompers, Paul A. and Vuolteenaho, Tuomo, Who Underreacts to Cash-Flow News? Evidence from Trading between Individuals and Institutions. Available at SSRN: https://ssrn.com/abstract=270100 or http://dx.doi.org/10.2139/ssrn.270100

Randolph B. Cohen

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-6674 (Phone)
617-496-6592 (Fax)

Paul A. Gompers

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-6297 (Phone)
617-496-8443 (Fax)

Harvard University - Entrepreneurial Management Unit ( email )

Cambridge, MA 02163
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI)

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Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Tuomo Vuolteenaho (Contact Author)

Arrowstreet Capital, LP ( email )

44 Brattle St., 5th Floor
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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