In the most recent methods for event study, corporate disclosure as quantified by bank loan data was linked to market efficiency. We explore this association in a laboratory setting, with three different experimental treatments.
Our results are that prices make rash moves when new information is added to the market, causing unaddressed evaluation errors (under-reaction) that don’t correct till the end of trading.
Information is distributed more freely when markets operate more efficiently.
Business is inherently plagued by information asymmetry, from the quality of products to worker performance, matches between friends and spouses, even trades between companies. Now, thanks to technological advancements, all of us can now access the highest-quality information available – suggesting that the era of asymmetric information might be upon us, good or bad.
Yet, in practice it’s not always obvious whether the information a company releases is good or bad; companies can try to cover up private data if they’re being forced to release it to the public – struggling companies will also shy away from disclosing negative credit information to lenders and bring it up to date only rarely (Gustafson et al. 2021).
We are using loan data as an analog of corporate transparency to determine the impact of different information asymmetry on the efficiency of the stock market. In our findings, we find that low information asymmetry levels allow for analyst predictions to be correct and investors make momentum gains from buying winners and contrarian gains from selling losers. Additionally, the more loans that default, the larger the asymmetric information effects of joint-equity commercial banks since multiple lending banks mitigates this asymmetry effect.
The market fails under high levels of information asymmetry.
Information asymmetry has been an area of intense recent interest, as a reason why individual finance models don’t account for momentum in stock prices. This article contains three important conclusions: (1) it connects the relationship between information asymmetry and stock price returns with investor behavior and (2) it compares past winners and losers portfolios performance in various scenarios of information asymmetry and (3) provide insight into “white lie effects” prevalent in financial markets.
We produce and use a proxy of corporate transparency based on loans to measure informational asymmetry in the stock market. Loan default is a fantastic measure of information asymmetry, as if companies had a high level of information opaqueness, shares would get even farther away from their values, which investors can then exploit in order to make momentum profits by purchasing losers and selling winners accordingly.
Additionally, we find that the asymmetric information effect of loan defaults reduces with market turnover – in agreement with our finding that asymmetric information effects are minimized in active markets – indicating that information opacity in loan markets might also undermine market efficiency.
Markets are more efficient when information asymmetry is minimal.
The more information asymmetry the larger the discrepancy between the price of stocks and their value, which can provide traders with a way to make money through momentum or contrarian strategies. Winners and losers differ depending on the degree of information asymmetry, as previous experiments have shown. This paper complements this work by exploring how different levels of information asymmetry impact the returns of momentum and contrarian portfolios. In laboratory experiments, we can even control what subjects are given and see how prices behave in response to that information. Three experimental treatments of different levels of information asymmetry are available. Its findings show that higher levels of information asymmetry have the best momentum trading outcomes and contrarian gain for the former winners; and lower levels have both positive and negative consequences.
Research has shown that information asymmetry improves when the firm is having multiple unpaid loans from banks. This is probably because banks track the credit history of the borrower better when more than one bank lends to a company, and in a time of economic distress companies are less likely to supply lenders with private data and hence default on loans than they would otherwise. By therefore, increasing bank lending would reduce information asymmetry in market economies by decreasing information asymmetry.