Idiosyncratic Risk and Corporate Transactions

50 Pages Posted: 16 Mar 2010 Last revised: 12 Apr 2010

Itzhak Ben-David

Ohio State University - Fisher College of Business, Finance Department; National Bureau of Economic Research (NBER)

Darren T. Roulstone

Ohio State University (OSU) - Fisher College of Business

Date Written: March 1, 2010

Abstract

It has been documented that insiders trade when they perceive their firms are mispriced and when they hold private information about future cash flows. Based on these findings, we test whether insiders at firms with high-idiosyncratic risk (which is associated both with financial anomalies and with greater private information in prices) earn higher returns to their trades than insiders at firms with lower idiosyncratic risk. We document that, indeed, the profitability of corporate transactions (insider purchases and sales, and share repurchases) increases dramatically with idiosyncratic risk. Corporate transactions are contrarian and the magnitudes of returns prior to and following trades increase with idiosyncratic risk. In further analyses, we find little evidence that these patterns relate to private information: they are not explained by common proxies for future cash-flow news and are not mitigated by increased regulatory oversight of insider trading since mid-1990s. Conversely, we document evidence indicating that high-idiosyncratic risk stocks are priced less efficiently: institutional investors are slow to respond to corporate transactions and prices following trades drift for several months.

Keywords: Limits to Arbitrage,Insider Trading,Repurchases,Seasoned Equity Offerings,SEO,Arbitrage,Institutional investors,private information,public information,market frictions,managers,equity issuance,abnormal returns,idiosyncratic risk,corporate governance,directors,managers,disclosure,arbitrageurs,returns

JEL Classification: G11, G12, G14, G32, G35

Suggested Citation

Ben-David, Itzhak and Roulstone, Darren T., Idiosyncratic Risk and Corporate Transactions (March 1, 2010). Available at SSRN: https://ssrn.com/abstract=972618 or http://dx.doi.org/10.2139/ssrn.972618

Itzhak Ben-David

Ohio State University - Fisher College of Business, Finance Department ( email )

2100 Neil Avenue
Fisher 700D
Columbus, OH 43210-1144
United States
773 988 1353 (Phone)

HOME PAGE: http://fisher.osu.edu/fin/faculty/Ben-David/index.htm

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

HOME PAGE: http://fisher.osu.edu/fin/faculty/Ben-David/

Darren T. Roulstone (Contact Author)

Ohio State University (OSU) - Fisher College of Business ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States

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