Who Underreacts to Cash-flow News? Evidence from Trading between Individuals and Institutions

Randolph B. Cohen, Paul A. Gompers, Tuomo Vuolteenaho
2001 Social Science Research Network  
A large body of literature suggests that firm-level stock prices "underreact" to news about future cash flows; i.e., shocks to a firm's expected cash flows are positively correlated with shocks to expected returns on its stock. We examine the joint behavior of returns, cash-flow news, and trading between individuals and institutions. Institutions buy shares from (sell shares to) individuals in response to positive (negative) cash-flow news, thus exploiting the underreaction phenomenon.
more » ... ons are not simply following price momentum strategies: When price goes up (down) in the absence of any cash-flow news, institutions sell shares to (buy shares from) individuals. Although institutions are trading in the "right" direction, institutions as a group outperform individuals by only 1.44% per annum before transaction and other costs, because they are extremely conservative in deviating from the value-weighted market index.
doi:10.2139/ssrn.270100 fatcat:onaofg3exbcodfwsctbfkcxmye