Does public financial news resolve asymmetric information? Forthcoming in Review of Financial Studies

I use uniquely comprehensive data on financial news events to test four predictions from an asymmetric information model of a firm’s stock price. Certain investors trade on in-formation before it becomes public; then, public news levels the playing field for other investors, increasing their willingness to accommodate a persistent liquidity shock. Empir-ically, I measure public information using firms ’ stock returns on news days in the Dow Jones archive. I find four patterns in postnews returns and trading volume that are con-sistent with the asymmetric information model’s predictions. Some evidence is, moreover, inconsistent with alternative theories in which traders interpret news differently for rational or behavioral reasons. (JEL G14) This study uses 29 years of data on all publicly traded U.S. firms in the Dow Jones (DJ) news archive to examine how firms ’ information environments change during 2.2 million news events. This is one of the largest quantita-tive records of financial news events ever constructed, allowing for a uniquely comprehensive analysis of the role of news in stock pricing. I propose and test a model of a firm’s stock price in which a public news story eliminates an information asymmetry between two groups of traders. Before the news, one investor group has superior information but also incurs a persistent liq-uidity shock. The news story then informs the relatively uninformed investor group, making them less wary of providing liquidity to the informed traders; because they are risk averse, the relatively uninformed investors do not fully accommodate the liquidity shock on the day of the news event. This the-oretical model is similar to the Kim and Verrecchia (1991), Wang (1994)