Mullin, Wallace P.: Gradual Incorporation of Information Into Stock Prices: An Empirical Study of Informed Trading
World Conference Econometric Society, 2000, Seattle

Sara Fisher Ellison, Stanford University
Wallace P. Mullin, Michigan State University
Gradual Incorporation of Information Into Stock Prices: An Empirical Study of Informed Trading
Session: C-13-24  Wednesday 16 August 2000  by Mullin, Wallace P.
This paper explores an environment in which the incorporation of information into stock prices is gradual, and develops appropriate estimation techniques. A large theoretical literature addresses how the trading process itself may incorporate private information into stock prices gradually. In particular, in the Kyle (1985) model, one or a small number of informed traders use their market power over their private information to maximize profits dynamically. We use the functional form predictions from Kyle in our estimation, and the results from a sample of targets of tender offers are consistent with the model. We find that price movements are sensitive to the current divergence between price and the value of the stock revealed at the announcement date. Moreover, this sensitivity grows as the announcement date approaches.
In addition, we estimate the date at which the insider becomes informed, and we find a wide dispersion and a bimodal distribution in these ``transition dates.'' The latter feature suggests two types of information structures, one where the secret is well-kept and one where significant preannouncement leakage occurs.
Our findings have implications for event study methodology. Given the heterogeneity in estimated firm-specific transition times, employing a uniform event window to capture pre-event information leakage would be inefficient. A superior approach is to modify the standard event study methodology so as to jointly estimate information release and the effect of that information.

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