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Why Does Financial Strength Forecast Stock Returns? Evidence from Subsequent Demand by Institutional Investors

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  • Nicole Y. Choi
  • Richard W. Sias

Abstract

Using institutional investor demand as a proxy for revisions in sophisticated investors' expectations, we test whether financial strength information is gradually impounded over time. Consistent with the gradual incorporation of information, financial strength predicts both future returns and future institutional investor demand. Further consistent with the gradual incorporation of information, more sophisticated transient (high-turnover) institutions respond to financial strength signals prior to less sophisticated, nontransient institutions. A number of additional tests suggest that financial strength forecasts stock returns, at least in part, because it forecasts institutional demand, and institutional demand drives prices. The Author 2012. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

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  • Nicole Y. Choi & Richard W. Sias, 2012. "Why Does Financial Strength Forecast Stock Returns? Evidence from Subsequent Demand by Institutional Investors," The Review of Financial Studies, Society for Financial Studies, vol. 25(5), pages 1550-1587.
    • Handle: RePEc:oup:rfinst:v:25:y:2012:i:5:p:1550-1587
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