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

Randolph B. Cohen, Paul A. Gompers, Tuomo Vuolteenaho

NBER Working Paper No. 8793
Issued in February 2002
NBER Program(s):   AP   CF

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 estimate a vector autoregession to examine the joint behavior of returns, cash-flow news, and trading between individuals and institutions. Our main finding is that institutions buy shares from individuals in response to good cash-flow news, thus exploiting the underreaction phenomenon. Institutions are not simply following price momentum strategies: When price goes up in the absence of positive cash-flow news, institutions sell shares to individuals. Although institutions are trading in the 'right' direction, institutions as a group outperform individuals by only 1.44 percent per annum before transaction and other costs, because they are extremely conservative in deviating from the value-weight market index.

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Document Object Identifier (DOI): 10.3386/w8793

Published: Cohen, Randolph B., Paul A. Gompers and Tuomo Vuolteenaho. "Who Underreacts To Cash-Flow News? Evidence From Trading Between Individuals And Institutions," Journal of Financial Economics, 2002, v66(2-3,Nov-Dec), 409-462. citation courtesy of

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