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

71 Pages Posted: 14 Feb 2002  

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)

Multiple version iconThere are 2 versions of this paper

Date Written: February 2002

Abstract

A large body of literature suggests that firm-level stock prices 'underreact' to news about future cash flows, i.e., shocks to a firm's expected cash flows are positively correlated with shocks to expected returns on its stock. 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. Although institutions are trading in the 'right' direction, institutions as a group outperform individuals by only 1.44 percent per annum before transaction and other costs, because they are extremely conservative in deviating from the value-weight market index.

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 (February 2002). NBER Working Paper No. w8793. Available at SSRN: https://ssrn.com/abstract=300755

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 (Contact Author)

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)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

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

Tuomo Vuolteenaho

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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