51 Pages Posted: 27 Mar 2007
Security analysts tend to bias stock recommendations upward, particularly if they are affiliated with the underwriter. We analyze how investors account for such distortions. Using the NYSE Trades and Quotations database, we find that large traders adjust their trading response downward: they exert buy pressure following strong buy recommendations, no reaction to buy recommendations, and selling pressure following hold recommendations. This discounting is even more pronounced when the analyst has an underwriter affiliation. Small traders, instead, follow recommendations literally. They exert positive pressure following both buy and strong buy recommendations and zero pressure following hold recommendations. We discuss possible explanations for the differences in trading response, including information costs and investor naiveté.
Keywords: Stock recommendations, Trade reaction, Individual and institutional investors, Conflicts of interest, Behavioral finance
JEL Classification: G14, G25, G29, D82, D83
Suggested Citation: Suggested Citation
Malmendier, Ulrike and Shanthikumar, Devin M., Are Small Investors Naive About Incentives?. Journal of Financial Economics, Forthcoming. Available at SSRN: https://ssrn.com/abstract=975028