DescriptionThis dissertation consists of three chapters that examine the association between speculative trading and future returns, managerial disclosure policy and market response to earnings news, respectively.
In the first chapter, I construct a novel measure for speculative trading and examine its asset pricing implications. This measure is motivated by a stream of analytical research linking disagreement to speculative trading. I find that the measure for speculative trading is negatively and significantly associated with future excess returns. I also find that the negative relationship is more pronounced for firms with more binding-short sales constraints, higher idiosyncratic volatility, lower market capitalization and lower analyst coverage. The negative relationship is also more pronounced when market sentiment is higher. I further find that my measure performs better in explaining the cross-section of stock returns than several proxies for speculative trading.
In the second chapter, I examine the properties of management forecasts in the presence of speculative trading. Using the measure of speculative trading from the first chapter of the dissertation and the exogenous variation in speculative trading due to the reconstitution of the Russell 1000/2000 indices, I find that speculative trading reduces the frequency, likelihood, and precision of management forecasts. Consistent with theory, this relationship is significantly stronger when short sale constraints are more binding, and when managers have strong equity-based incentives. I also find that managers sell equity to benefit from the speculative premium. In summary, the results suggest that managers issue forecasts opportunistically in response to speculative trading: they either keep silent, or issue fewer and more ambiguous forecasts to prolong speculative trading and the resulting speculative premium in equity prices.
In the third chapter, I examine the relationship between speculative trading and market response to earnings news. Intuitively, disagreement and the resulting speculative trading should not persist in an environment with a wealth of public information since public information plays a role in aligning the beliefs of investors. Nevertheless, prior literature finds pervasive speculative trading in stock markets with large public information flow. I argue that speculators’ underreaction to public information can explain the prevalence of speculative trading. Because of overconfidence, speculators rely too much on their own beliefs compared to rational investors and thus underreact to public news that is inconsistent with their priors. Consistent with my argument, I find that greater speculative trading is associated with lower earnings response coefficient (ERC) and stronger post-earning announcement drift. I also find that greater speculative trading is associated with stronger post analyst-revision drift. Additional evidence suggests that speculators’ underreaction to earnings news alleviates managerial myopia.