The traditional financial theory attributes security returns to market- or factor-based risk, with no role ascribed to other influences. In this research, the authors argue for including investor demand as an additional variable in explaining returns. Can changes in investor demand generate systematic changes in security returns?
There are several significant, well-documented benefits of index funds. In addition to outperforming a large majority of actively managed funds, they tend to have low fees, low turnover (resulting in low trading costs and high tax efficiency), broad diversification, high liquidity, and near-zero tracking error (generally assumed to mean that they incur negligible trading costs).
How information affects asset prices is of fundamental importance. Public information flows through news, while private information flows through trading. We study how stock prices respond to these two information flows in the context of two major asset pricing anomalies— short-term reversal and momentum. Firms release news primarily during non-trading hours, which is reflected in overnight returns. While investors trade primarily intraday, which is reflected in intraday returns. Using a novel dataset that spans almost a century, we find that portfolios formed on past intraday returns display strong reversal and momentum. In contrast, portfolios formed on past overnight returns display no reversal or momentum. These results are consistent with underreaction theories of momentum, where investors underreact to the information conveyed by the trades of other investors.
Traditional finance theory suggests that stocks prices always reflect their fair market values based on publicly available information. Or in academic parlance, the "semi-strong" form efficient markets hypothesis serves as the null. What are the implications of this hypothesis? Well, the hypothesis suggests that the only reason a stock price will move is due to a shift in fundamentals (either through a change in expected cash flows or via the discount rate). But what about supply and demand shifts?