Does Anticipated Information Impose a Cost on Risk-Averse Investors? A Test of the Hirshleifer Effect

Abstract

This paper theoretically and empirically investigates how the risk of future adverse price changes created by the anticipated arrival of information influences risk-averse investors’ trading decisions in institutionally imperfect capital markets. Specifically, I examine how the selling activity of individual investors immediately following an earnings announcement is influenced by the trade-off between risk-sharing benefits of immediate trade and explicit transaction costs imposed on such trades. Consistent with my theoretically derived predictions, I find that investors’ current trading decisions are less sensitive to the incremental transaction costs created by short-term capital gains taxes on trading profits, as both the duration and intensity of the risk of future adverse price changes increase. This evidence is consistent with an incremental cost to investors that results from the revelation of precise information, which is commonly referred to as the Hirshleifer Effect (Hirshleifer, 1971; Verrecchia, 1982).