The paper discloses a new asset pricing anomaly. The conventional models fail to correctly price firms with defined benefit pension plans. Mispricing arises as a function of the funding level of the pension plan. Firms with a pension surplus have a premium in returns and, more significantly, firms with a shortfall have a discount. We provide evidence in favor of an explanation that is based on investors' underreaction to pension plan information. Working under this hypothesis, and exploiting the features of the regulatory environment, we build trading strategies that earn abnormal returns of about 12% annually, adjusted for the exposures to the market, size, book-to-market, and momentum factors. The findings of the paper have relevance for corporate and public policies, and, possibly, for the debate on momentum in assets prices.
This paper documents that at the individual stock level insiders sales peak many months before a large drop in the stock price, while insiders purchases peak only the month before a large jump. We provide a theoretical explanation for this phenomenon based on trading constraints and asymmetric information. We test our hypothesis against competing stories such as patterns of insider trading driven by earnings announcement dates, or insiders timing their trades to evade prosecution. Finally we provide new evidence regarding crashes and the degree of information asymmetry.
Journal of Economic Literature Classification Numbers: D82, G11, G12, G14, G28Keywords: Insider Trading, Rational Expectations Equilibrium, Trading Constraints, Volatility, Crashes. * We are very grateful to Antoni Sureda for outstanding research assistance and to Anthony Tay for helpful pointers early in the project. We also thank Joachim Voth for very insightful comments
This paper introduces a theory of market incompleteness based on the information transmission role of prices and its adverse impact on the provision of insurance in financial markets. We analyse a simple security design model in which the number and payoff of securities are endogenous. Agents have rational expectations and differ in information, endowments, and attitudes toward risk. When markets are incomplete, equilibrium prices are typically partially revealing, while full relevation is attained with complete markets. The optimality of complete or incomplete markets depends on whether the adverse selection effect (the unwillingness of agents to trade risks when they are informationally disadvantaged) is stronger or weaker than the Hirshleifer effect (the impossibility of trading risks that have already been resolved), as new securities are issued and prices reveal more information. When the Hirshleifer effect dominates, an incomplete set of securities is preferred by all agents, and generates a higher volume of trade.
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