Stock Price and Information - Essay Example

This will benefit existing shareholders.however; the potential new shareholders are not stupid. They will infer overvaluation from the new issue, thereby bidding down the stock price on the announcement date of the issue. So, for the information asymmetry stock price is raised.therefore, information affects stock price in many way. There is substantial evidence of short-term stock price continuation, which the prior literature often attributes to investor under reaction to new information. 1 By information uncertainty, it is meant that ambiguity with respect to the implications of new information for a firm's value, which potentially stems from two sources: The volatility of a firm's underlying fundamentals and poor information.

Here, main hypothesis is that if investors under react to public information, they will under react even more in cases of greater information uncertainty. The testable implication is that greater information uncertainty about the impact of news on stock value leads to higher expected stock returns following good news but lower expected stock returns following bad news relative to the returns of stocks about which there is less information uncertainty. . Several papers including Chan, Jegadeesh, and Lakonishok (1996) attribute price continuation to a gradual market response to information.

Hirshleifer (2001) and Daniel, Hirshleifer, and Subrahmanyam (1998, 2001) posit that psychological biases are increased when there is more uncertainty.New information is public, easily categorized as good or bad, and occurs fairly frequently. There are six proxies for information uncertainty: Firm size, firm age, analyst coverage, dispersion in analyst forecasts, return volatility, and cash flow volatility.2 For each of the six proxies, greater information uncertainty leads to relatively lower future stock returns following bad news and relatively higher future returns following good news, suggesting that uncertainty delays the flow of information into stock prices.

In other words, the market reaction to new information is relatively complete for low-uncertainty stocks, and there is little news-based return predictability. For high-uncertainty stocks, on the other hand, the market reaction is far from complete. Good news predicts relatively higher future returns and bad news predicts relatively lower future returns. This relation between information of uncertainty and future returns has used in prior empirical studies. Further assurance that is missing risk factors does not drive the results by documenting a similar return pattern around subsequent earnings announcement dates.

The opposite effects of information uncertainty on stock returns following good vs. bad news amplify the results of trading strategies. As a result, trading strategies that buy good-news stocks and short bad-news stocks work particularly well when limited to high-uncertainty stocks. For example, a momentum