Information Production, Analyst Following and Diversification Discount: A Market Microstructure Approach

46 Pages Posted: 17 Aug 2001

See all articles by Qiao Liu

Qiao Liu

The University of Hong Kong - School of Economics and Finance; Peking University - Guanghua School of Management

Rong Qi

ING Aeltus Asset Management

Date Written: July 2001

Abstract

This paper offers an information-based explanation for the well-documented diversification discount. While explicitly assuming that the stock prices convey valuable information to the management, our model shows that the value loss from diversification is due to the insufficient information production. If more investors are willing to follow and actively trade a certain stock, more information will be transmitted to the managers and the corresponding value loss tends to decline. Thus, our model provides a rationale for the existence and cross-sectional variation in diversification discount. Using the analyst coverage as the proxy for information production, we find empirical evidence, which supports our model implications: holding firm characteristics fixed, the analyst converge explains a significant portion of the cross-sectional variation in diversification discount during the period 1985-1999.

Keywords: Information, Financial Analyst, Diversification Discount, Market Microstructure

JEL Classification: G34, G14

Suggested Citation

Liu, Qiao and Qi, Rong, Information Production, Analyst Following and Diversification Discount: A Market Microstructure Approach (July 2001). Available at SSRN: https://ssrn.com/abstract=279250 or http://dx.doi.org/10.2139/ssrn.279250

Qiao Liu (Contact Author)

The University of Hong Kong - School of Economics and Finance ( email )

School of Economics and Finance
Pokfulam
Hong Kong
Hong Kong
852-2859-1059 (Phone)
852-2548-1152 (Fax)

Peking University - Guanghua School of Management ( email )

Peking University
Beijing, Beijing 100871
China

Rong Qi

ING Aeltus Asset Management ( email )

10 State House Square
Hartford, CT 06457
United States

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