Speculating on Private Information: Buy the Rumor, Sell the News

We test theoretical models of how investors should trade on short-lived private information. Our empirical identification rests on information leakage that occurs before analyst recommendations are publicly announced. Consistent with the theory, institutions, who likely possess a short-lived informational advantage, “buy the rumor and sell the news, ” buying before analyst upgrades and then selling when upgrades are announced. Placebo tests using earnings announcements confirm that these trading patterns are unique to instances where institutional investors have a short-lived informational advantage. Individuals, who are unlikely to be informed early, do not buy before or sell on upgrade announcements. The results are largely supportive of the theoretical predictions and provide the first empirical evidence of the “sell the news ” behavior