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To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jfineco.2005.05.006 Byline: David Hirshleifer (a), Avanidhar Subrahmanyam (b), Sheridan Titman (c) Abstract: We provide a model in which irrational investors trade based upon considerations that have no inherent connection to fundamentals. However, trading activity affects market prices, and because of feedback from security prices to cash flows, the irrational trades influence underlying cash flows. As a result, irrational investors can, in some situations, earn abnormal (i.e., risk-adjusted) profits that can exceed the abnormal profits of rational informed investors. Although the trading of irrational investors cause prices to deviate from fundamental values, stock prices follow a random walk. Author Affiliation: (a) Fisher College of Business, The Ohio State University, Columbus, OH 43210-1144, USA (b) Anderson Graduate School of Management, University of California, Los Angeles, California, 90095, USA (c) College of Business Administration, University of Texas, Austin, Texas, 78712, USA Article History: Received 21 June 2004; Revised 4 April 2005; Accepted 26 May 2005 Article Note: (footnote) [star] We thank an anonymous referee, Nicholas Barberis, Bhagwan Chowdhry, Chitru Fernando, Laura Frieder, George Jiang, Chris Lamoureux, Seongyeon Lim, Steve Lippman, Richard Roll, Jose Scheinkman, Shu Yan, and participants in seminars at the London Business School, the London School of Economics, UC Irvine, UCLA, University of Arizona, University of Texas at Dallas, University of Oklahoma, the Latin American Finance Association Meetings, the Madrid 2005 Conference on Behavioral Finance, and the conference discussant Tano Santos for useful comments.

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jfineco.2004.06.004 Byline: Tarun Chordia (a), Richard Roll (b), Avanidhar Subrahmanyam (b) Abstract: Daily returns for stocks listed on the New York Exchange (NYSE) are not serially correlated while order imbalances on the same stocks are highly persistent. These empirical facts can be reconciled if sophisticated investors react to order imbalances within the trading day by undertaking enough countervailing trades to remove serial dependence over a daily horizon. How long does this actually take? The pattern of intra-day serial dependence reveals that it takes more than five minutes but less than sixty minutes. Author Affiliation: (a) Goizueta Business School, Emory University, Atlanta, GA 30322, USA (b) The Anderson School at UCLA, 110 Westwood Plaza, Suite C408, Los Angeles, CA 90095-1481, USA Article Note: (footnote) [star] We thank an anonymous referee, Peter Bossaerts, Michael Brennan, Jeff Busse, Eugene Fama, Laura Frieder, Will Goetzmann, Clifton Green, Andrew Karolyi, Pete Kyle, Francis Longstaff, Elizabeth Odders-White, Mike Piwowar, Stephen Ross, Ross Valkanov, Kumar Venkataraman, Ingrid Werner, and seminar participants at Bocconi University, INSEAD, Princeton University, Southern Methodist University, Texas A&M University, Universite de Paris Dauphine, Universite de Toulouse, University of Texas, the New York Stock Exchange, Dimensional Fund Advisors, the 2002 Western Finance Association Conference, and the 2002 University of Maryland Accounting and Finance Conference for valuable comments and suggestions. We are grateful for financial support from the Q-Group.

An analysis of the effect of the inventory on the daily stock price movement is furnished. The effect of order imbalance is analyzed.

Market returns are affected by order imbalance according to research on New York Stock Exchange buy and sell orders.

This paper documents a negative strong relation betweeen average returns and both the level and trading activity-related variables such as dollar trading volume and share turnover.

Non-risk security characteristics exert marginal explanatory power relative to the arbitrage pricing theory benchmark. Utilization of Fama-MacBeth-type regressions has revealed evidence establishing the existence of return momentum, size and book-to-market effects. The size and book-to-market effects weakened when Fama and French factors were utilized during repetition of the analysis while the momentum and trading volume effects remain.

Models of price information in securities markets indicate that uninformed investors incur substantial illiquidity costs created by privately informed investors. This implies that relatively illiquid securities should have higher required rates of return. The link between stock returns and illiquidity is investigated using a wide variety of empirical methodologies from asset pricing and market microstructure research. The two variables are found to be significantly related after the impact of the stock price level is taken into account, and after the Fama and French (1193) factors are used to adjust for risk.

The association between the number of analysts evaluating a stock and the adverse selection costs of transacting was studied. The concept of adverse selection costs is derived from a model developed by Admati and Pfleiderer which posits that investors with greater market information can inflict substantial liquidity costs on other investors. Intraday data on 1,500 common stocks reported by the Institute for the Study of Security Markets in 1988 were analyzed. It was concluded that a greater number of investment analysts will result in a decline in the adverse selection costs of transacting.