Sophisticated Investors and Market Efficiency: Evidence from a Natural Experiment
NBER Working Paper No. 24552
We study how sophisticated investors, when faced with changes in information environment, adjust their information acquisition and trading behavior, and how these changes in turn affect market efficiency. We find that, after exogenous reductions of analyst coverage due to closures of brokerage firms, hedge funds scale up information acquisition. They trade more aggressively and earn higher abnormal returns on the affected stocks. Moreover, the participation of hedge fund significantly mitigates the impairment of market efficiency caused by coverage reductions. Our results show a substitution effect between sophisticated investors and public information providers in facilitating market efficiency in a causal framework.
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Document Object Identifier (DOI): 10.3386/w24552