The information content of stock markets around the world: A cultural explanation

We draw on the psychology literature on cross-country cultural differences to explain the information content of stock markets around the world. We show that cultural dimensions in the studies of Hofstede (1980, 2001) such as individualism and uncertainty avoidance closely relate to several behavioral biases widely discussed in accounting and finance research. These cultural dimensions also signal different risk preferences. We argue that behavioral biases and risk preferences influence how international investors act on firm-specific information and empirically test whether individualism and uncertainty avoidance indexes can explain the cross-country information content of stock markets. We compute R2 from the market model to measure the general information content of stock markets in the long term, abnormal return variance, and abnormal trading volume around earnings announcements to measure the short-term information content of earnings announcements. Using more than 150,000 earnings announcements from 42 countries for the period 1990–2006, we find that the information content of stock markets is higher in more individualistic countries and in low uncertainty-avoiding countries. The relations between cultural dimensions and measures of information content are robust to the inclusion of several control variables or the use of updated cultural indexes that account for possible changes in cultures over time.