Essays on the Role of Informed Trading in Stock Markets

The first essay, Chapter 3, shows that uninformed investors require a price discount to hold the stock because they perceive a new information uncertainty risk when short-sale constraints are binding and informed trading is absent. Stock prices become less informative when short-sale constraints keep informed investors out of the market. The less informative prices create a new information uncertainty risk for uninformed investors because uninformed investors are unable to figure out the true value of the stock without knowing the private information of informed investors. The new information uncertainty risk effect becomes greater if stocks have greater information uncertainty, which reflects the convenience of learning fundamental news. The second essay, Chapter 4, examines two special new information uncertainty risk effects by controlling for trading volume. When volume is large, uninformed investors observe high buying pressure but cannot distinguish noise demand from information-based buying. They confront this new information uncertainty risk and demand premium to buy stock. Thus, overvaluation caused by short-sale constraints is reduced. When volume is small, uninformed investors convince that informed investors have negative information but do not know how bad the information is. They will not hold the stock under this new information uncertainty risk and therefore future return will becomes worse. The third essay, Chapter 5, studies the impact of informed trading to the momentum effect. It proposes that if momentum is a result of underreaction and if informed trading identifies stocks with underreaction, the presence of informed trading predicts future momentum effect. Consistently, the empirical results show that momentum effect arises when informed trading is present. Greater informed trading leads to greater momentum effect. Although information uncertainty is related to both informed trading and momentum, the identified relationship between

Name dc:type.qualificationname

phd

Level dc:type.qualificationlevel

doctoral

Grantor dc:publisher.institution

City University London

Year dc:date.issued

2009

Author dc:creator

• Chen, Y.

• HG Finance