Essays in information and asset prices

Abstract

This thesis uncover the dynamics of asset prices in response to informational events. These studies can provide insights to understand not only the behavior of financial market participants but also the economic mechanisms by which asset prices form. The first essay, ``Complementarity of Passive and Active Investment on Stock Price Efficiency'', examines how passive and active investment collectively affect the efficiency of stock prices. I document the complementary role of passive and active investment in the improvement of stock price efficiency. The relationship between stock price efficiency and passive/active investment, which is one of the long-standing theme in finance, is subject to an endogeneity problem. Using the annual reconstitution of Russell 1000 and 2000 indexes as an instrument, I find an improvement in efficiency due to an exogenous increase in passive investment, specifically in stocks widely held by actively managed funds. These active funds are compensated with higher returns for their effort. An increase in analyst following and a decrease in analyst forecast dispersion are identified as economic channels of the efficiency improvement. The result implies that active funds seek out inefficient stocks and ultimately experience superior returns due to the improvement in efficiency from passive investment. This study highlights the complementarity of passive and active investment on stock price efficiency, which has not been documented in the literature. In the second essay, ``The Role of Efficient Analysts in Stock and Option Markets'', we investigate the fundamental role of analyst recommendations in terms of the true efficient price discovery using the signal-to-noise volatility ratio constructed with high-frequency data. While exiting studies on the effect of analyst recommendations focus on their ex post impact on stock prices, we find that only recommendation revisions that contribute to the true efficient price discovery play an influential role in the stock and option markets. In particular, abnormal stock returns are observed in expected directions only for the recommendations that deliver information about the true efficient price of a stock. Furthermore, we observe that those informative revisions resolve uncertainty about a firm and reduce jump risk in its stock price. This study highlights the intrinsic role of analysts in financial market, and documents that the analysts who do their fundamental work indeed affect stock and option markets. In the third essay,``Realized Skewness for Information Ambiguity'', we propose realized skewness constructed using high-frequency data as a measure of information ambiguity. In this working paper, we rely on the fact that ambiguity-averse investors respond asymmetrically to ambiguous (intangible) information. We find that a significant decrease of realized skewness around analysts' earnings forecasts and recommendation releases. Furthermore, as realized skewness proxies the degree of information ambiguity, we document that negative realized skewness predicts subsequent lower returns around information releases after controlling for return continuations. To further prove an economic significance of our finding, we provide a zero-net investment strategy incorporating our finding, which achieves a Sharpe ratio of 1.766 with 0.83\% of monthly average returns. The results highlight how the asymmetric behavior of investors in response to information releases can be used to infer subsequent dynamics of asset prices.