Does Internet Research Activity by Sophisticated Investors Lead to Heightened Adverse Selection?

59 Pages Posted: 31 Dec 2019

See all articles by Alan Kwan

Alan Kwan

The University of Hong Kong

Christina Zhu

University of Pennsylvania - The Wharton School

Date Written: December 2, 2019

Abstract

We provide direct evidence of an association between the internet research activity of sophisticated investors around public announcements and heightened adverse selection. Prior literature finds that adverse selection increases at public announcements (Lee et al. 1993; Kim and Verrecchia 1994). The posited mechanism is that earnings announcements allow a subset of traders to make superior assessments of firm value based on the disclosure. Using a unique dataset of internet research activity on business media sites matched to the IP addresses of investors, we provide support for this mechanism by identifying a positive relation between pre-earnings announcement information gathering of sophisticated investors and illiquidity at the time of the announcement. As predicted by Kim and Verrecchia (1994), illiquidity increases at the time of the announcement as the intensity of information gathering increases. In supplemental analyses, we continue to find support for business media content on the internet as a source of complementary information in interpreting earnings announcement.

Keywords: earnings announcements, adverse selection, sophisticated investors, media, liquidity, information acquisition, technology

JEL Classification: G14, M41, D83

Suggested Citation

Kwan, Alan and Zhu, Christina, Does Internet Research Activity by Sophisticated Investors Lead to Heightened Adverse Selection? (December 2, 2019). Available at SSRN: https://ssrn.com/abstract=3501801 or http://dx.doi.org/10.2139/ssrn.3501801

Alan Kwan

The University of Hong Kong ( email )

Pokfulam Road
Hong Kong, Pokfulam HK
China

Christina Zhu (Contact Author)

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

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