We especially thank an anonymous referee and Rob Stambaugh, the editor, for helpful suggestions that greatly improved the article. Andrew Ang and Bob Hodrick both acknowledge support from the NSF.

Award at the 2005 European Finance Association Meeting, to the retail broker and discount

We build a model that helps explain why increases in liquidity⎯such as lower bid-ask spreads, a lower price impact of trade, or higher turnover⎯predict lower subsequent returns in both firm-level and aggregate data. The model features a class of irrational investors, who underreact to the information contained in order flow, thereby boosting liquidity. In the presence of short-sales constraints, high liquidity is a symptom of the fact that the market is dominated by these irrational investors, and hence is overvalued. This theory can also explain how managers might successfully time the market for seasoned equity offerings, by simply following a rule of thumb that involves issuing when the SEO market is particularly liquid. Empirically, we find that: i) aggregate measures of equity issuance and share turnover are highly correlated; yet ii) in a multiple regression, both have incremental predictive power for future equal-weighted market returns.

This paper investigates the dynamic relation between net individual investor trading and short-horizon returns for a large cross-section of NYSE stocks. The evidence indicates that individuals tend to buy stocks following declines in the previous month and sell following price increases. We document positive excess returns in the month following intense buying by individuals and negative excess returns after individuals sell, which we show is distinct from the previously shown past return or volume effects. The patterns we document are consistent with the notion that risk-averse individuals provide liquidity to meet institutional demand for immediacy. FOR A VARIETY OF REASONS, financial economists tend to view individuals and institutions differently. In particular, while institutions are viewed as informed investors, individuals are believed to have psychological biases and are often thought of as the proverbial noise traders in the sense of Kyle (1985) or Black (1986). One of the questions of interest to researchers in finance is how the behavior of different investor clienteles or their interaction in the market affects

EFA conferences. Meir Statman acknowledges support from the Dean Witter Foundation. We

Individual investor trading results in systematic and economically large losses. Using a complete trading history of all investors in Taiwan, we document that the aggregate portfolio of individuals suffers an annual performance penalty of 3.8 percentage points. Individual investor losses are equivalent to 2.2 % of Taiwan’s gross domestic product or 2.8% of the total personal income. Virtually all individual trading losses can be traced to their aggressive orders. In contrast, institutions enjoy an annual performance boost of 1.5 percentage points, and both the aggressive and passive trades of institutions are profitable. Foreign institutions garner nearly half of institutional profits.

This article investigates the dynamic relation between market-wide trading activity and returns in 46 markets. Many stock markets exhibit a strong positive relation between turnover and past returns. These findings stand up in the face of various controls for volatility, alternative definitions of turnover, differing sample periods, and are present at both the weekly and daily frequency. The relation is more statistically and economically significant in countries with high levels of corruption, with short-sale restrictions, and in which market volatility is high. Do investors trade more when markets have done well in the recent past? If their trading relates to past returns, why do they behave that way? Answering these questions is important to our understanding of the determinants of trading volume, liquidity, and stock returns. Further-more, answers to these questions can help market makers and liquidity providers obtain forecasts of trading intensity, portfolio managers devise efficient trading strategies, and regulators and policymakers find ways to improve the liquidity and efficiency of financial markets.

I use uniquely comprehensive data on financial news events to test four predictions from an asymmetric information model of a firm’s stock price. Certain investors trade on in-formation before it becomes public; then, public news levels the playing field for other investors, increasing their willingness to accommodate a persistent liquidity shock. Empir-ically, I measure public information using firms ’ stock returns on news days in the Dow Jones archive. I find four patterns in postnews returns and trading volume that are con-sistent with the asymmetric information model’s predictions. Some evidence is, moreover, inconsistent with alternative theories in which traders interpret news differently for rational or behavioral reasons. (JEL G14) This study uses 29 years of data on all publicly traded U.S. firms in the Dow Jones (DJ) news archive to examine how firms ’ information environments change during 2.2 million news events. This is one of the largest quantita-tive records of financial news events ever constructed, allowing for a uniquely comprehensive analysis of the role of news in stock pricing. I propose and test a model of a firm’s stock price in which a public news story eliminates an information asymmetry between two groups of traders. Before the news, one investor group has superior information but also incurs a persistent liq-uidity shock. The news story then informs the relatively uninformed investor group, making them less wary of providing liquidity to the informed traders; because they are risk averse, the relatively uninformed investors do not fully accommodate the liquidity shock on the day of the news event. This the-oretical model is similar to the Kim and Verrecchia (1991), Wang (1994),

This paper tests whether stock market investors appropriately distinguish new and old information about firms. I define the staleness of a news story as its textual similarity to the previous ten stories about the same firm. I find that firms ’ stock returns respond less to stale news. Even so, a firm’s return on the day of stale news negatively predicts its return in the following week. Individual investors trade more aggressively on news when news is stale. The subsequent return reversal is significantly larger in stocks with above-average individual investor trading activity. These results are consistent with the idea that individual investors overreact to stale information, leading to temporary movements in firms ’ stock prices.

We examine short selling in US stocks based on new SEC-mandated data for 2005. There is a tremendous amount of short selling in our sample: short sales represent 24% of NYSE and 31% of Nasdaq share volume. Short sellers increase their trading following positive returns and they correctly predict future negative abnormal returns. These patterns are robust to controlling for voluntary liquidity provision and for opportunistic risk-bearing by short sellers. The results are consistent with short sellers trading on short-term overreaction of stock prices. A trading strategy based on daily short-selling activity generates significant positive returns during the sample period. (JEL G12, G14) There is currently tremendous interest in short selling not only from academics, but also from issuers, media representatives, the Securities and Exchange Commission (SEC), and Congress. Academics generally share the view that short sellers help markets correct short-term deviations of stock prices from fundamental value. This view is by no means universally held, and many issuers and media representatives instead characterize short sellers as immoral, unethical, and downright un-American.