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Informed contrarian trades and stock returns

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  • Chang, Sanders S.
  • Albert Wang, F.

Abstract

We develop a novel measure for the probability of informed trading. This measure, termed PCM, captures the adverse selection component of bid-ask spreads, becomes elevated around earnings announcements, and exhibits similar time-series patterns to price impact. Returns in double-sorted portfolios increase in PCM while controlling for liquidity. A long-short portfolio based on PCM generates 18.3% abnormal return annually. PCM significantly explains cross-sectional returns while controlling for other factors. This effect is robust to alternative specifications and remains significant after the decimalization in 2001. In sum, PCM is easy to implement and serves as an effective proxy for informed trading.

Suggested Citation

  • Chang, Sanders S. & Albert Wang, F., 2019. "Informed contrarian trades and stock returns," Journal of Financial Markets, Elsevier, vol. 42(C), pages 75-93.
    • Handle: RePEc:eee:finmar:v:42:y:2019:i:c:p:75-93
    DOI: 10.1016/j.finmar.2018.08.002
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    2. Kropiński, Paweł & Bosek, Bartłomiej & Pudo, Mikołaj, 2024. "State ownership, probability of informed trading, and profitability potential: Evidence from the Warsaw Stock Exchange," International Review of Financial Analysis, Elsevier, vol. 95(PB).
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    More about this item

    Keywords

    Information asymmetry; Contrarian trading; Stock returns;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G19 - Financial Economics - - General Financial Markets - - - Other

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