Does Forecasting Price Efficiency (FPE) Affect Revelatory Price Efficiency (RPE)?

Abstract

This paper shows how FPE affects RPE. It offers evidence that stock under- and over-valuation signaled by corporate events change stock RPE by changing the information collection behavior of informed investors. Corporate events, performed not only by a firm but also by its peers, that signal over-valuation (Over-Value events) predict RPE negatively, whereas those signal under-valuation (Under-Value events) predict RPE positively. After Over-Value events, RPE decreases more for firms with worse investment opportunities, poor corporate governance, more entrenched managers, and higher short sale constraints. After Under-Value events, RPE increases more for firms with better investment opportunities and managers who listen to prices and during boom times. Results are stronger when Over-Value events are performed when a firm has high Q or high Price-to-Value (P/V), and Under-Value events when the firm has low Q or low P/V. The Broader implication of these findings is that market under-valuations are corrected more quickly than over-valuations, implying that market over-valuations are stickier and more prevalent in the economy.

Keywords: Forecasting Price Efficiency, Revelatory Price Efficiency, Feedback Effect, Price Efficiency, Price Informativeness, Information Acquisition

JEL Classification: G10, G30, G14, G31