How does the stock market respond to news reports about a company? Previous work has found that it takes a few days for prices to fully absorb news, and this underreaction has been attributed to investors’ limited ability to process information. We find evidence for an alternative explanation: Sophisticated institutional investors trade slowly on news to avoid tipping their hands. Once we control for this effect, we find that the market actually overreacts to news.
Academic interest in how markets process information dates back to Eugene Fama’s pioneering work in the 1960’s. Fama argued that markets are highly informationally efficient, … Read more