The Informational Role of Institutional Investors and Financial Analysts in The Market

Journal of Financial Markets 14 (2011) 465493
www.elsevier.com/locate/nmar
The informational role of institutional investors and

nancial analysts in the market$
Wen-I Chuanga,n, Bong-Soo Leeb
a
Department of Finance, National Taiwan University, No. 1, Section 4, Roosevelt Road, Taipei 10617, Taiwan
b
Department of Finance, Florida State University, Tallahassee, FL 32306-1110, USA
Available online 1 January 2011
Abstract
We provide empirical evidence on the impact of limited market participation on the informational role
played by institutions and analysts in the market. Our ndings are as follow. First, the price adjustment of
stocks that are favored by institutions and analysts and associated with low information set-up costs helps
better predict market-wide information. Second, rms that are primarily held by individuals and followed
by fewer analysts tend to respond more sluggishly to market-wide information than do rms that are
primarily held by institutions and followed by more analysts. This nding is partially attributed to public
information generated by the high institutional-ownership and analyst coverage rms with good corporate
governance. Third, high institutional-ownership portfolios and high analyst coverage portfolios play a
complementary role in predicting market returns. Fourth, there is little systematic difference between high
institutional-ownership portfolios and high analyst coverage portfolios in predicting the returns of stocks
with different characteristics. Fifth, good market-wide news diffuses more slowly across securities than
does bad market-wide news, and this nding primarily occurs in periods of NBER-dated expansions.
& 2010 Elsevier B.V. All rights reserved.
JEL classification: G14; G20
Keywords: Limited market participation; Information set-up cost; Institutional investors; Financial analysts;
Market-wide information
$
The authors are grateful to Eugene Kandel (the editor), an anonymous referee, Yuanchen Chang and seminar
participants at the National Taiwan University, National Chengchi University, National Central University, and
2007 FMA Annual Meeting in Orlando for helpful comments. Wen-I Chuang gratefully acknowledges the
nancial support from the National Science Council of the Republic of China (NSC 95-2416-H-011-018). The
usual disclaimer applies.
n
Corresponding author. Tel.: 886 2 3366 9578; fax: 886 2 2366 0764.
E-mail addresses: wichuang@management.ntu.edu.tw (W.-I. Chuang), blee2@cob.fsu.edu (B.-S. Lee).
1386-4181/$ - see front matter & 2010 Elsevier B.V. All rights reserved.
doi:10.1016/j.nmar.2010.12.001
466
W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493
1. Introduction
In analyzing the source of contrarian prots, Lo and Mackinlay (1990) uncover a striking
nding that the returns on the portfolio of small stocks are correlated with the lagged returns
on the portfolio of large stocks, but not vice versa. Although they attribute this nding to the
tendency of small stocks to adjust more slowly to market-wide information than large stocks,
they provide little explanation for why rm size per se may be an important determinant of the
speed of price adjustment to information. Considerable research has been conducted to nd
factors that can account for information transmission across securities beyond the size effect.
Candidates that have been put forward to account for information transmission across
securities include the proportion of stocks held by institutional investors (Badrinath, Kale, and
Noe, 1995; Sias and Starks, 1997), the number of analysts following a rm (Brennan,
Jegadeesh, and Swaminathan, 1993), and trading volume (Chordia and Swaminathan, 2000).1
Badrinath, Kale, and Noe (1995) hypothesize that because of differential information
set-up costs (Merton, 1987) and/or legal restrictions arising from the prudent man
regulations, both implying limited market participation, institutional investors gather
information about only a subset of stocks. If the information they gather has common
effects across securities, then the returns on stocks held by institutional investors, who have
more resources to perform systematic investigations into the securities than do individual
investors, help predict the returns on stocks held by individual investors. Consistent with
their hypothesis, Badrinath, Kale, and Noe (1995) nd that the returns on the portfolios
with the highest level of institutional ownership lead those with lower levels of institutional
ownership. Sias and Starks (1997) report a similar nding. They interpret their nding as
consistent with the hypothesis that institutional trading reects market-wide information,
which is incorporated into stocks with low institutional holdings.
However, given the implications of limited market participation, institutional trading may
not always be informative about market-wide information. For example, due to information
set-up costs and/or the prudent man rules, institutional investors will prefer investing in large
stocks to investing in small stocks, and therefore have more incentive to actively perform
systematic investigations into large rms than small rms. Then, the lead-lag relation between
the returns on portfolios with different degrees of institutional ownership within large rm size
groups can be attributable to the effect of information set-up costs and/or the prudent man
rules that make institutional trading help better predict market-wide information, which is
ultimately incorporated into stocks with low institutional holdings.
Institutional investors may also invest in small stocks for the purpose of portfolio
diversication or increasing prots.2 However, they will devote less effort to conducting
1
There are two additional explanations that have been proposed for cross-autocorrelations among portfolio
returns. The rst group attributes cross-autocorrelations in portfolio returns to time-varying expected returns
(e.g., Conrad and Kaul, 1988). A variation of this explanation claims that cross-autocorrelations are the result of
portfolio autocorrelations and contemporaneous correlations (e.g., Boudoukh, Richardson, and Whitelaw, 1994).
According to this explanation, portfolio cross-autocorrelations should disappear once portfolio autocorrelations
are taken into account. The second group attributes portfolio autocorrelations and cross-autocorrelations to
market imperfections or microstructure biases such as thin trading (e.g., Boudoukh, Richardson, and Whitelaw,
1994).
2
Bennett, Sias, and Starks (2003) show that over time institutional investors have shifted their preferences
toward smaller stocks because such stocks offer a relatively more attractive trade-off between risk and expected
return than do larger stocks.
467
systematic investigations into small stocks because the costs of information acquisition
for small rms are higher than for large rms (Merton, 1987). In this circumstance,
their trading in small stocks may reveal little market-wide information. Since full-time
professional institutional investors tend to pay more attention to market-wide information
that may have already been propagated for a while in the market than do part-time
individual investors, the lead-lag relation between the returns on portfolios with different
degrees of institutional ownership within small rm size groups can be attributable to the
fact that institutional investors more closely scrutinize and therefore respond more rapidly
to market-wide information than individual investors.
Some theoretical works show that as the number of informed investors increases, the
share price will respond to new information more rapidly (e.g., Kyle, 1985; Holden and
Subrahmanyam, 1992; Foster and Viswanathan, 1993). Using the number of analysts as a
proxy for the number of informed investors, Brennan, Jegadeesh, and Swaminathan (1993)
nd that the returns on the portfolios of rms that are followed by many analysts tend to
lead those of rms that are followed by a few analysts, even when the rms are of
approximately the same size. Although nancial analysts are free from the prudent man
regulations, they still have to consider the costs of information acquisition when they
choose rms to cover and analyze. Consequently, as in the case of institutional investors,
nancial analysts may not always uncover and disseminate new information to the market,
and sometimes they refer to other information sources in order to reduce their costs
of collecting information. Indeed, Sant and Zaman (1996) and Easley, OHara, and
Paperman (1998) nd some evidence in support of this view.
Hong and Stein (1999) develop a dynamic model in which information diffuses gradually
across the investing public, implying that the informativeness of investors trading is a
decreasing function of time. That is, investors who receive new market-wide information
rst will revise their valuations of stock prices immediately and their trading will reect
this information, while those who receive the same information later will update their
valuations with a lag and their trading is not so informative in a timely manner. Combined
with limited market participation, stocks that are favored by institutional investors
and nancial analysts and incorporate new market-wide information into their prices
faster than others are more likely to be those with low information set-up costs, such as
large and liquid stocks. Other stocks with high information set-up costs, although favored
by institutional investors and nancial analysts (to a less extent), may not have such an
informational role.
One common observation from Brennan, Jegadeesh, and Swaminathan (1993),
Badrinath, Kale, and Noe (1995), and Sias and Starks (1997) is that high-institution
portfolios and high-analyst portfolios adjust faster to market-wide information than lowinstitution portfolios and low-analyst portfolios. But they do not analyze whether this
adjustment is informative to the market based on the implications of limited market
participation. Our study attempts to ll this void in the literature. In addition, we
investigate whether there is a complementary or substitution effect between highinstitution portfolios and high-analyst portfolios in predicting market returns, and whether
there is any systematic difference between their informational roles in predicting the
returns of stocks with different characteristics.
To address these issues, we form various portfolios and calculate both the daily and
weekly returns of these portfolios. Specically, we form size-institutional ownership and
volume-institutional ownership portfolios, and size-analyst coverage and volume-analyst
468
coverage portfolios to investigate the informational role played by institutional investors

and nancial analysts in the market. To proxy market-wide information, we use the
returns on both equal- and value-weighted market portfolios. Then, we compare the
relative predictive power of the portfolios with that of the equal- and value-weighted
market portfolios by performing the Granger causality test.3
Consistent with the previous studies, our results show that within each size or volume
group, the returns on the portfolios with the highest institutional ownership lead those
with the lowest institutional ownership, and the returns on the portfolios with the highest
analyst coverage lead those with the lowest analyst coverage. This implies that rms that
are primarily held by individual investors and followed by fewer nancial analysts tend to
respond more sluggishly to new market-wide information than do rms that are primarily
held by institutional investors and followed by more nancial analysts. Moreover, this
lead-lag relation is found to be partially attributed to the public information generated
by the high institutional-ownership and analyst coverage rms with good corporate
governance.
More importantly, we nd that within the large size and high volume groups, returns on
the portfolios with the highest institutional ownership lead returns on the market portfolio,
while within the small size and low volume groups, returns on the portfolios with the
highest institutional ownership lag returns on the market portfolio. The portfolios
associated with analyst coverage yield similar results. Put together, these results are
consistent with the hypothesis that, due to the effect of limited market participation,
institutional investors and nancial analysts collect information more actively about large
and liquid stocks and thus their price adjustment tends to respond to new market-wide
information in a timely manner, whereas they do less actively about small and illiquid
stocks and thus their price adjustment tends to do so with a lag.
We further examine whether there is any complementary or substitution effect between
high-institution portfolios and high-analyst portfolios in predicting market returns. We
nd that they play a complementary role in predicting market returns. To investigate
whether there is any systematic difference between high-institution portfolios and highanalyst portfolios in predicting the returns of stocks with different characteristics, we
construct portfolios based on diverse characteristics, such as book-to-market ratio, market
capitalization, trading volume, return volatility, and age (i.e., the number of years since the
rms rst appearance in the CRSP databases). We nd little evidence for the systematic
difference. Instead, we nd some evidence that is consistent with the hypothesis that
institutional investors tend to predict the returns of stocks with different characteristics
better than nancial analysts do.
Finally, we nd that stocks with the lowest institutional ownership (analyst coverage)
tend to respond more slowly to good market-wide news emanating from the price
adjustment of stocks with the highest institutional ownership (analyst coverage) than to
bad news. This is consistent with the nding of McQueen, Pinegar, and Thorley (1996) that
small stocks tend to have more delayed reactions to good market-wide news emanating
from the price adjustment of large stocks than to bad news. Moreover, we nd that this
3
Previous studies do not consider the relative predictive power of the portfolios and the market portfolio. One
exception is Chordia and Swaminathan (2000). However, their analyses do not provide any evidence on the effect
of limited market participation on the informational role played by institutional investors and nancial analysts in
the market.
469
asymmetric delayed response occurs primarily during periods of NBER-dated expansions.

This is consistent with the hypothesis that investors pay less attention to good market-wide
news during periods of expansion and pay more attention to all market-wide news during
periods of contraction.
The balance of the paper is organized as follows. In Section 2, we describe the data and
discuss the empirical frameworks. In Section 3, we present the empirical results, and we
conclude in Section 4.
2. Data and empirical framework
2.1. Data
Our sample consists of all rms listed on the NYSE during the period of January 1982 to
December 2004. We exclude any rm that is a prime, a closed-end fund, a real estate
investment trust (REIT), or an American Depository Receipt (ADR). To be included in
our sample, a rm must have available information on stock prices, market capitalization,
trading volume, the number of shares held by institutional investors, and the number of
nancial analysts following it. Stock prices, market capitalization, and trading volume are
obtained from the Center for Research in Security Prices (CRSP) database. Specically, we
use trading turnover, dened as the ratio of the number of shares traded in a given day to
the total number of shares outstanding at the end of the day, as a measure of trading
volume.4
The number of shares held by institutional investors is obtained from the January, April,
July, and October issues of Standard and Poors Security Owners Stock Guides. The
institutional holdings they report originate from Vickers Stock Research Corporation.
Specically, data in the January issue indicate third-quarter institutional holdings in the
previous year (see also Nofsinger and Sias, 1999). Fractional institutional ownership is
dened as the ratio of the number of shares held by institutional investors to the number of
shares outstanding. The number of nancial analysts following each sample rm is taken
from the IBES tapes. The number of nancial analysts following a particular rm in a
given quarter is dened as the number of nancial analysts making an annual earnings
forecast in January, April, July, and October.5
Previous studies document that rm size and trading volume are highly positively
correlated with institutional holdings and analyst coverage (e.g., Brennan, Jegadeesh, and
Swaminathan, 1993; Badrinath, Kale, and Noe, 1995; Sias and Starks, 1997; Hong, Lim,
and Stein, 2000; Naes and Skjeltorp, 2003; Rubin, 2007). These high positive correlations
naturally lead to the question of whether the size or volume effects are subsumed by the
institutional ownership or analyst coverage effects or vice versa. To effectively evaluate the
informational role of institutional investors and nancial analysts in the market, we divide
4
Lo and Wang (2000) argue that using trading turnover as a measure of trading volume has an advantage in
that it is unaffected by neutral changes of units such as stock splits and stock dividends. Moreover, one problem
with using the number of shares traded as a measure of trading volume is that it is unscaled and, therefore, highly
correlated with rm size. Chordia and Swaminathan (2000) show that the correlation between trading turnover
and rm size is much lower than that between other measures of trading volume and rm size.
5
We use the number of nancial analysts who make an annual earnings forecast rather than a quarterly
earnings forecast. This is because prior to year 2000 the number of nancial analysts making quarterly earnings
forecast is not available for most of sample rms.
470
our sample of stocks in the following manner. For size-institutional ownership portfolios,
six size groups are formed at the beginning of each quarter by ranking all sample stocks by
their market capitalization. Then, each size group is further classied into six groups based
on the fraction of shares held by institutional investors. Thus, each sample stock is
assigned to one of 36 groups. We construct volume-institutional ownership portfolios,
size-analyst coverage portfolios, volume-analyst coverage portfolios, analyst coverageinstitutional ownership portfolios, and institutional ownership-analyst coverage portfolios
in a similar manner.6 This sorting algorithm ensures that the size-institutional ownership
and volume-institutional ownership portfolios are different in terms of institutional
ownership but similar in terms of size and volume, respectively. A similar classication
applies to other portfolios. For example, size-analyst coverage and volume-analyst
coverage portfolios are different in terms of analyst coverage but similar in terms of size
and volume, respectively.
Once portfolios are formed in this manner at the beginning of each quarter, their
composition remains unchanged for the remainder of the quarter. Then, daily equalweighted portfolio returns are computed for each portfolio by averaging daily the returns
of the stocks in the portfolio. To minimize the effect of non-synchronous trading on
cross-autocorrelations, we follow the Chordia and Swaminathan (2000) methodology and
exclude stocks that did not trade on date t or t1 when computing portfolio returns for
date t. For each portfolio, we obtain 5,553 observations of daily portfolio returns.7
2.2. Summary statistics
Table 1 reports descriptive statistics on various portfolios. We nd that the mean values of
the rm size of size-institutional ownership and size-analyst coverage portfolios are similar for
each size group. A comparable observation is made for each volume group. This indicates that
we are successful in reducing the association between size and institutional ownership/analyst
coverage and between volume and institutional ownership/analyst coverage.
The limited market participation implies that institutional investors and nancial
analysts have different incentives in collecting information about stocks with the
differential information set-up cost. Following the argument by Badrinath, Kale, and
Noe (1995), we use rm size as a proxy for the information set-up cost. We also use trading
volume, a common measure of liquidity in the literature, as another proxy. To gauge
whether different size or volume groups exhibit signicant differences to meet the
requirement that they have different characteristics in size or volume, we perform t-tests
for the difference in mean values of size or volume for adjacent two groups. Table 1 shows
that the t-statistics for two portfolios Pi versus Pi1 are statistically signicant at the
1% level for all adjacent size or volume groups, illustrating that our sorting algorithm
6
The volume-ranked portfolios are based on daily average trading turnover of the sample stocks over the
previous year before the portfolio formation date (see also Chordia and Swaminathan, 2000).
7
Previous studies document that non-synchronous trading is a more serious problem in daily data than in
weekly data (e.g., Kadlec and Patterson, 1999) and that Wednesday trading volume is higher relative to trading
volume on the other trading days (e.g., Barclay, Litzenberger, and Warner, 1990). To further alleviate the
concerns of the non-synchronous trading and non-trading problems, we also use Wednesday-to-Wednesday
portfolio returns to replicate all empirical tests in the paper. The weekly results show that all reported conclusions
drawn from the results of daily portfolio returns remain virtually unchanged. To conserve space, we do not report
the results using weekly portfolio returns. However, they are available from the authors upon request.
471
Table 1
Summary statistics for various portfolios.
Summary statistics for various portfolios are computed for the sample period from January 1983 to December
2004. For size groups, Pij refers to a portfolio of size i and institutional-ownership or analyst coverage j. i=1, 6
refer to the largest and smallest size portfolios, respectively. h and l refer to the highest and lowest institutionalownership or analyst coverage portfolios, respectively, within each size group i. For volume groups, Pij refers to a
portfolio of volume i and institutional-ownership or analyst coverage j. i=1, 6 refer to the highest and
lowest volume portfolios, respectively. h and l refer to the highest and lowest institutional-ownership or analyst
coverage portfolios, respectively, within each volume group i. For analyst coverage groups, Pij refers to a portfolio
of analyst coverage i and institutional ownership j. i=1, 6 refer to the highest and lowest analyst coverage
portfolios, respectively. h and l refer to the highest and lowest institutional ownership portfolios, respectively,
within each analyst coverage group i. For institutional ownership groups, Pij refers to a portfolio of institutional
ownership i and analyst coverage j. i=1, 6 refer to the highest and lowest institutional ownership portfolios,
respectively. h and l refer to the highest and lowest analyst coverage portfolios, respectively, within each
institutional ownership group i. Pem and Pvm refer to the equal- and value-weighted portfolios of all NYSE sample
rms, respectively. The mean size gures are in billions of dollars. The mean volume gures represent the average
percentage of trading turnover. The mean institutional ownership gures are in institutional ownership fraction.
The mean analyst coverage gures represent the average number of analysts following a sample rm. The
t-statistics for Pi versus Pi1 are the result of t-test for the difference in means of group i and group i1 of
portfolio formation criterion 1. For example, for the size-institutional ownership portfolios, portfolio formation
criterion 1 represents the mean market capitalization. The t-statistics for Pih versus Pil are the results of t-test for
the difference in means of groups h and l within each group i of portfolio formation criterion 2. For example, for
the size-institutional ownership portfolios, portfolio formation criterion 2 represents the mean institutional
ownership fraction.
Volume (%)
Institutional
ownership
Analyst
coverage
t-Statistics
for Pi vs. Pi1
t-Statistics
for Pih vs. Pil
Size-institutional ownership portfolios

0.061
1.101
9.864
P1h
P1l
0.064
0.857
18.952
P2h
0.061
1.111
2.742
P2l
0.051
0.827
2.607
P3h
0.064
1.091
1.228
P3l
0.056
0.821
1.140
0.061
1.085
0.624
P4h
P4l
0.062
0.855
0.602
P5h
0.057
1.101
0.318
P5l
0.061
0.934
0.291
0.072
1.131
0.132
P6h
P6l
0.105
1.271
0.079
0.416
0.263
0.482
0.270
0.511
0.270
0.490
0.235
0.435
0.250
0.424
0.265
0.806
0.324
0.829
0.281
0.821
0.225
0.805
0.190
0.774
0.171
0.661
0.114
21.278
22.776
17.006
16.605
13.991
11.971
11.090
7.779
8.385
5.370
6.094
3.385
11.665nnn
138.306nnn
17.014nnn
80.667nnn
20.798nnn
91.851nnn
17.307nnn
121.557nnn
19.225nnn
91.184nnn
51.223nnn
Volume-institutional ownership portfolios

0.047
1.301
2.250
P1h
P1l
0.163
1.481
1.325
P2h
0.072
1.067
2.679
P2l
0.079
1.254
2.332
P3h
0.076
0.991
3.732
P3l
0.081
1.110
2.651
P4h
0.064
0.926
3.971
P4l
0.074
1.031
2.165
P5h
0.063
0.913
3.849
P5l
0.056
0.946
1.879
P6h
0.053
0.816
2.402
P6l
0.049
0.880
1.222
0.919
0.950
0.466
0.459
0.340
0.334
0.260
0.254
0.193
0.185
0.115
0.082
0.838
0.270
0.819
0.282
0.800
0.269
0.774
0.243
0.730
0.195
0.656
0.114
15.721
8.444
14.381
9.322
14.344
9.196
13.436
9.523
12.808
8.670
9.563
5.297
26.779nnn
46.898nnn
28.954nnn
70.534nnn
28.945nnn
65.898nnn
27.284nnn
70.022nnn
23.033nnn
81.477nnn
35.926nnn
Portfolio returns
Mean (%)
Size
Std. dev. (%)
472
Table 1 (continued )
Size
Volume (%)
Institutional
ownership
Analyst
coverage
t-Statistics
for Pi vs. Pi1
t-Statistics
for Pih vs. Pil
24.043
9.635
3.619
3.052
1.708
1.472
0.870
0.753
0.458
0.382
0.198
0.107
0.383
0.403
0.504
0.381
0.586
0.342
0.560
0.360
0.509
0.296
0.530
0.324
0.582
0.604
0.590
0.570
0.586
0.507
0.581
0.512
0.560
0.403
0.498
0.329
33.432
12.981
25.218
9.110
21.888
5.843
17.461
3.557
13.350
2.043
9.504
1.145
11.505nnn
66.736nnn
17.596nnn
57.912nnn
23.510nnn
53.728nnn
25.221nnn
45.182nnn
22.921nnn
36.051nnn
24.921nnn
Volume-analyst coverage portfolios

0.070
1.385
6.046
P1h
P1l
0.084
1.500
0.603
P2h
0.062
1.135
10.193
P2l
0.061
1.241
0.464
P3h
0.058
1.031
14.605
P3l
0.079
1.117
0.486
P4h
0.071
1.010
16.991
P4l
0.067
1.080
0.496
P5h
0.057
0.984
22.026
P5l
0.050
1.022
1.061
P6h
0.060
0.880
21.841
P6l
0.049
0.845
0.398
0.957
0.811
0.443
0.436
0.329
0.326
0.258
0.253
0.196
0.190
0.134
0.098
0.658
0.460
0.636
0.480
0.603
0.461
0.561
0.454
0.498
0.407
0.431
0.291
31.245
3.188
26.660
3.500
27.318
3.253
26.955
2.962
25.877
2.452
20.869
1.517
5.840nnn
45.505nnn
28.751nnn
64.244nnn
21.676nnn
59.483nnn
28.512nnn
63.209nnn
21.174nnn
73.806nnn
45.233nnn
Portfolio returns
Mean (%)
Std. dev. (%)
Size-analyst coverage
0.048
P1h
P1l
0.065
0.049
P2h
P2l
0.062
P3h
0.042
P3l
0.074
0.066
P4h
P4l
0.047
P5h
0.079
P5l
0.047
0.083
P6h
P6l
0.081
Market portfolios
0.062
Pem
Pvm
0.054
Note:
nnn nn
, and
portfolios
1.084
1.157
1.055
1.069
0.971
1.102
1.212
1.000
1.231
0.982
1.299
1.268
0.741
0.938
n
denote signicance at the 1%, 5%, and 10% levels, respectively.
successfully captures the effect of limited market participation or the difference in the
information set-up cost. Moreover, from the magnitude of the mean values of institutional
holdings and analyst coverage in each size and volume group, we nd that both
institutional investors and nancial analysts tend to favor large and high volume stocks
over small and low volume stocks.
Table 1 also reports the t-statistics for two portfolios Pih versus Pil, where h and l refer to
the highest and lowest institutional-ownership and analyst coverage portfolios, respectively, within each size group or each volume group i. They are used to test whether
the portfolios have different degrees (or mean values) of institutional ownership within
each size or volume group and of analyst coverage within each size or volume group,
respectively. The results show that all t-statistics for Pih versus Pil are statistically
signicant at the 1% level, indicating that size- and volume-institutional ownership (sizeand volume-analyst coverage) portfolios have different degrees of institutional ownership
(analyst coverage) within each size or volume group, respectively.
473
2.3. Empirical framework

2.3.1. Vector autoregressions
Following Brennan, Jegadeesh, and Swaminathan (1993), we employ the vector autoregressions (VAR) to investigate the lead-lag relation between portfolio returns (see also Sias and
Starks, 1997; Chordia and Swaminathan, 2000). Brennan, Jegadeesh, and Swaminathan (1993)
demonstrate that the returns of portfolios that are rst to reect market-wide information will
predict the returns of portfolios that reect market-wide information later. To understand the
rationale behind the VAR, suppose that we want to test whether portfolio B returns lead
portfolio A returns. For this, we consider the following bivariate vector autoregressions:
RA;t aA
K
X
ak RA;tk
k1
RB;t aB
K
X
k1
K
X
bk RB;tk eA;t ;
dk RB;tk eB;t ;
k1
ck RA;tk
K
X
k1
where RA,t and RB,t are the returns of portfolios A and B, respectively. The number of lags in
each equation is chosen by considering both the Akaike (1974) information criterion (AIC) and
the Schwarz (1978) information criterion (SIC). In Eq. (1), if the lagged returns of portfolio B
can predict the current returns of portfolio A, controlling for the predictive power of the lagged
returns of portfolio A, the returns of portfolio B are said to Granger-cause the returns of
portfolio A. Following Chordia and Swaminathan (2000), we also examine whether the sum of
the coefcients associated with the returns of portfolio B in Eq. (1) is greater than zero.
Therefore, this version of the Granger causality tests examines not only for predictability but
also for the sign of predictability (or net effect).
Then, we focus on testing formally whether the ability of the lagged returns of portfolio
B to predict the current return of portfolio A is better than vice versa. We test this
hypothesis by examining whether the sum of the bk coefcients in Eq. (1) is greater than the
sum of the ck coefcients in Eq. (2). If the ability of the lagged returns of portfolio B to
predict the current return of portfolio A is better than vice versa, Brennan, Jegadeesh, and
Swaminathan (1993) theoretically demonstrate that the sum of the bk coefcients in Eq. (1)
should be signicantly greater than the sum of the ck coefcients in Eq. (2).8
We use the returns on the market portfolio to proxy market-wide information. This proxy is
important because it helps us identify the relative speed of price adjustment of stocks favored by
institutional investors and nancial analysts. For example, if the returns on the portfolios with
the highest institutional ownership Granger-cause those with the lowest institutional ownership,
this implies that the price adjustment of stocks favored by institutional investors to market-wide
information is faster than that of stocks favored by individual investors. Then, based on the
implications of limited market participation, two circumstances will occur. First, if the returns on
the highest institutional ownership portfolios with low information set-up costs Granger-cause
the returns on the market portfolio, this is consistent with the hypothesis that institutional
investors exert more effort to actively collect information about these stocks and thus the price
8
Brennan, Jegadeesh, and Swaminathan (1993) show that if the lagged returns of portfolio A predict the current
returns of portfolio B with a negative sign, it is simply a result of the fact that the returns of portfolio A adjust
more sluggishly to market-wide information than the returns of portfolio B.
474
adjustment of these stocks helps better predict market-wide information. Second, if the returns
on the market portfolio Granger-cause the returns on the highest institutional ownership
portfolios with high information set-up costs, this is consistent with the hypothesis that
institutional investors devote less effort to conducting systematic investigations into these stocks
and thus the price adjustment of these stocks has no predictive power for market-wide
information.
2.3.2. The complementary and substitution effects
To investigate whether high institutional-ownership portfolios and high analyst
coverage portfolios play a complementary or substitution role in predicting market
returns, we estimate the following four regressions:
Rm;t am
K
X
bk Rm;tk
k1
Rm;t am
K
X
K
X
bk Rm;tk
K
X
k1
K
X
lk RB;tk em;t ;
jk RC;tk em;t ;
dk RD;tk em;t ;
k1
bk Rm;tk
k1
Rm;t am
gk RA;tk em;t ;
k1
k1
Rm;t am
K
X
K
X
k1
bk Rm;tk
K
X
k1
where Rm,t is the return of the market portfolio, and RA,t, RB,t, RC,t, and RD,t are the returns of
portfolios A, B, C, and D, respectively. Specically, portfolios A and B represent the high and
low institutional-ownership (analyst coverage) portfolios, respectively, and portfolios C and D
represent the high analyst coverage (institutional-ownership) portfolios within the high and
low institutional-ownership (analyst coverage) groups, respectively. The lag length in Eqs. (3)
to (6) is chosen considering both the AIC and the SIC.
In these four regressions, we use R-square to measure the predictive power of a portfolio
for market returns. If high analyst coverage portfolios complement (substitute) high
institutional-ownership portfolios in predicting market returns, the difference between the
predictive power of the high and low institutional-ownership portfolios should be lower
(higher) than the difference between the predictive power of the high analyst coverage
within the high and low institutional-ownership groups. In other words, the difference
between the R-squares of regressions (3) and (4) should be less (greater) than that between
the R-squares of regressions (5) and (6) if high analyst coverage portfolios complement
(substitute) high institutional-ownership portfolios in predicting market returns. The test
of whether high institutional-ownership portfolios complement (substitute) high analyst
coverage portfolios is conducted analogously.
2.3.3. On the systematic difference between institutional investors and financial analysts
As mentioned above, institutional investors are affected by the prudent man rules while
nancial analysts are not. This difference may imply some systematic difference in the market
segments in that the high institutional-ownership and high analyst coverage stocks lead stocks
475
with different characteristics. For example, the returns on the portfolios of high institutionalownership stocks may better predict the future returns on the portfolios of value stocks, large
stocks, high volume stocks, low volatility stocks, and old stocks, while the returns on the
portfolios of high analyst coverage stocks may better predict the future returns on the portfolios
of growth stocks, small stocks, low volume stocks, high volatility stocks, and young stocks. To
investigate this implication, we estimate the following regression:
RA;t aA
K
X
k1
bk RA;tk
K
X
gk RB;tk
k1
K
X
lk RC;tk eA;t ;
k1
where RA,t, RB,t, and RC,t are the daily returns on the portfolios A, B, and C, respectively.
Specically, portfolio A represents the portfolio of value stocks or the portfolio of growth
stocks, portfolio B the portfolio of high institutional-ownership stocks, and portfolio C the
portfolio of high analyst coverage stocks.
In Eq. (7), the ability of the lagged returns of portfolio B and that of lagged returns of
portfolio C to predict the current returns of portfolio A, controlling for the predictive
power of the lagged returns of portfolio A, are measured by testing whether gk=0, for all k
and whether lk=0, for all k, respectively. The rationale for the test in Eq. (7) is similar to
that for the test in Eqs. (1) and (2). Therefore, if we nd that the sum of the gk coefcients
is signicantly greater than the sum of the lk coefcients in Eq. (7), it implies that the
ability of the returns of portfolio B to predict the returns of portfolio A is better than that
of the returns of portfolio C.
2.3.4. Asymmetric regression
McQueen, Pinegar, and Thorley (1996) nd that the cross-autocorrelation puzzle
documented by Lo and Mackinlay (1990) is primarily associated with a slow response by
some small stocks to good, but not to bad, market-wide news. A variation of our empirical
framework of the bivariate vector autoregression of Eqs. (1) and (2) can also provide
insight into the cross-autocorrelation between the returns of two portfolios under
consideration. Here, we also investigate whether the cross-autocorrelation of our
portfolios exhibits an asymmetric response to good and bad market-wide news.
Following the McQueen, Pinegar, and Thorley (1996) method, we employ the following
asymmetric regression to investigate the asymmetric response of the returns of one
portfolio to positive and negative returns of the other portfolio:
RB;t aB
K
X
k0
bUP
B;k RA;tk DA;tk
K
X
bDN
B;k RA;tk 1DA;tk eB;t ;
k0
where RA,t and RB,t are the returns of portfolios A and B, respectively, and D
A;tk is a
dummy variable that takes on a value of one if RA,t is positive and zero otherwise.9 The lag
length in Eq. (8) is determined based on the AIC and the SIC. It can be shown that
portfolio B adjusts more slowly to good market-wide news emanating from portfolio A
than to bad news if and only if the contemporaneous beta associated with the positive
returns of portfolio A, bUP
B;0 ; is less than that associated with the negative returns of
9
We have checked the returns of portfolio A and found that none of them is zero over the sample period.
Therefore, it is safe to dene D

A;tk as the positive returns of portfolio A and dene 1DA;tk as the negative
returns of portfolio A.
476
PK
UP
portfolio A, bDN
B;0 ; and the sum of the lagged betas in an up market,
k1 bB;k ; is greater
PK
DN
than that in a down market, k1 bB;k : In terms of the asymmetric regression in Eq. (8),
PK
PK
DN
UP
DN
this translates into examining whether bUP
B;0 obB;0 and
k1 bB;k 4
k1 bB;k (see also
McQueen, Pinegar, and Thorley, 1996).10 The rationale behind this result is that if
portfolio B responds more sluggishly to good market-wide news released from portfolio A
than to bad news, it should respond less to todays good market-wide news than to todays
bad news, and respond more to past good market-wide news than to past bad news. It
should be noted that in order to make a conclusion about the asymmetric response, the
above two conditions should hold simultaneously.
Here, we go one step further to investigate whether the asymmetric response is related to
the state of the macro economy. To this end, we modify Eq. (8) as follows:
RB;t ail
K
X
EXP
bUP-EXP
RA;tk D
B;k
A;tk Dtk
k0
K
X
EXP
bDN-EXP
RA;tk 1D
B;k
A;tk Dtk
k0
M
X
m0
M
X
EXP
bUP-CON
RA;tm D
B;m
A;tm 1Dtm
EXP
bDN-CON
RA;tm 1D
B;m
iA;tm 1Dtm eB;t ;
m0
is a dummy variable and takes on a value of one during an NBER-dated

where DEXP
t
expansion and zero otherwise.11 The lag length in Eq. (9) is determined based on the AIC
and the SIC. As discussed above, to investigate the relation between asymmetric responses
and the state of the macro economy, we examine the relative magnitudes of the
contemporaneous betas and the relative magnitudes of the sum of the lagged betas during
the period of NBER-dated expansions and contractions.12
3. Empirical results
3.1. The informational role of institutional investors
Table 2 presents the estimation results of the bivariate VAR for the size-institutional
ownership and the equal-weighted market portfolios. Specically, Panel A of Table 2
presents the estimation results of the bivariate VAR for 12 size-institutional ownership
portfolios, Pih (Portfolio A) versus Pil (Portfolio B), where h and l refer to the highest and
lowest institutional-ownership portfolios, respectively, within each size group i. The wbc(1)
statistic is employed to measure the relative ability of two portfolios in predicting each
10
Chordia and Swaminathans (2000) Dimson beta regressions use the same concept to measure the relative
speeds of adjustment of portfolios to market-wide information.
11
According to the denition of a business cycle by the NBER, any period should belong to either a period of
expansion or a period of contraction. Thus, our dummy variables should cover all the periods with no period in
between.
12
We also examine whether market-wide news displays the different patterns of diffusion across securities
during the business cycle, but nd no signicant differences.
477
Table 2
Vector autoregressions for the size-institutional ownership and the market portfolios.
The following bivariate VAR is estimated to examine the relative ability of one portfolio to predict the other
portfolio for the sample period from January 1983 to December 2004:
RA;t aA
K
X
ak RA;tk
k1
RB;t aB
K
X
K
X
bk RB;tk eA;t ;
dk RB;tk eB;t ;
k1
ck RA;tk
k1
K
X
k1
where RA,t and RB,t are the daily returns on the portfolios A and B, respectively. Pij refers to an equal-weighted
portfolio of size i and institutional-ownership j. i=1, 6 refer to the largest and smallest size portfolios, respectively.
h and l refer to the highest and lowest institutional-ownership portfolios, respectively, within each size group i. Pem
refers to the equal-weighted portfolios of all NYSE sample rms. The number of lags in each equation is chosen
by considering both the Akaike (1974) information criterion (AIC) and the Schwarz (1978) information criterion
(SIC). The wb(K) and wc(K) statistics obtained from the Wald test are a joint test of the null hypothesis based on
the causality restrictions. The wb(1) and wc(1) statistics obtained from the Wald test are used to test the null
P
P
hypothesis that bk=0 and P
that P
ck=0, respectively. The wbc(1) statistic obtained from the Wald test is used to
test the null hypothesis that bk= ck.
wb(K) or
wc(K)
LHS
variable
(K)
P
bk or
P
ck
wb(1) or
wc(1)
wbc(1)
Panel
R1h,t
R1l,t
R2h,t
R2l,t
R3h,t
R3l,t
A: Pih
(4)
(4)
(4)
(4)
(4)
(4)
(portfolio A) versus Pil

14.247nnn 0.180
10.560nn
0.071
7.899n
0.120
31.732nnn
0.104
10.613nn
0.165
61.926nnn
0.197
Panel
R1h,t
Rem,t
R2h,t
Rem,t
R3h,t
Rem,t
B: Pih
(6)
(6)
(6)
(6)
(6)
(6)
(portfolio A)
23.956nnn
55.008nnn
15.610nn
54.076nnn
8.898
27.731nnn
Panel
R1l,t
Rem,t
R2l,t
Rem,t
R3l,t
Rem,t
C: Pil (portfolio A) versus Pem (portfolio B)

(6) 19.626nnn
0.080
1.227
0.161
(6) 22.704nnn
0.024
0.254
(7) 21.196nnn
0.026
0.192
1.185
(7)
11.722
0.090
2.666
(5) 52.950nnn
0.219
15.178nnn 15.511nnn
(5) 15.423nnn
0.170 11.723nnn
Note:
nnn
nn
, and
(portfolio B)
12.302nnn 11.901nnn
5.765nn
4.467nn 8.064nnn
12.162nnn
8.583nnn 20.934nnn
42.502nnn
versus Pem (portfolio

0.287 11.769nnn
0.151
14.027nnn
0.160
2.731n
0.160
12.456nnn
0.127
1.733
0.166
13.503nnn
wb(K) or
wc(K)
P
bk or
P
ck
(5) 12.354nn
(5) 73.609nnn
(4)
3.918
(4) 49.288nnn
(5) 13.533nn
(5) 90.194nnn
0.194
0.240
0.027
0.178
0.080
0.257
10.699nnn 26.382nnn
50.074nnn
0.344
8.784nnn
32.233nnn
7.024
11.117nnn
51.174nnn
(4)
(4)
(7)
(7)
(7)
(7)
10.000nn
7.810n
66.128nnn
34.654nnn
142.337nnn
34.963nnn
0.052
0.100
0.502
0.015
0.729
0.068
0.434
0.181
7.187nnn
23.372nnn 12.967nnn
0.100
61.566nnn 41.025nnn
2.870n
(4)
(4)
(9)
(9)
(7)
(7)
77.125nnn
14.946nnn
145.260nnn
21.032nn
135.110nnn
4.847
0.323
0.136
0.406
0.060
0.545
0.006
37.254nnn 26.686nnn
10.120nnn
24.392nnn 13.305nnn
1.146
64.510nnn 45.289nnn
0.062
LHS
variable
(K)
R4h,t
R4l,t
R5h,t
R5l,t
R6h,t
R6l,t
B)
13.943nnn R4h,t
Rem,t
5.533nn R5h,t
Rem,t
4.664nn R5h,t
Rem,t
R4l,t
Rem,t
R5l,t
Rem,t
R6l,t
Rem,t
wb(1) or
wc(1)
wbc(1)
other. The results show that for each size group, the sum of the ckP
coefcients
P is greater
than that of the bk coefcients. Moreover, the null hypothesis that bk= ck, which we
test by the wbc(1) statistic, is rejected at conventional signicance levels for all size groups.
Consistent with Badrinath, Kale, and Noe (1995) and Sias and Starks (1997), these results
478
indicate that the ability of the lagged returns on the portfolio with the highest institutional
ownership to predict the current returns on the portfolio with the lowest institutional
ownership is better than vice versa.
Panel B of Table 2 reports the results of the Granger causality tests for the portfolios with the
highest institutional holdings (i.e., Pih for i=1, 2, y , and 6) and the equal-weighted market
portfolio, Pem. Based on the relative magnitudes of the sum of the bk coefcients and that of the
ck coefcients and the wbc(1) statistics, the ability of the returns of P1h, P2h, and P3h to predict
the returns of Pem is better than vice versa. However, the results show that the ability of the
returns of Pem to predict the returns of P5h and P6h is better than vice versa. Combined with the
results of Panel A of Table 2, these results are consistent with the hypothesis that institutional
investors make more effort to actively collect information about large stocks and thus the price
adjustment of large stocks helps better predict market-wide information, while that of small
stocks has little predictive power.
Panel C of Table 2 reports the results of the Granger causality tests for the portfolios
with the lowest institutional holdings (i.e., Pil for i=1, 2, y , and 6) and the equalweighted market portfolio, Pem. Based on the relative magnitudes of the sum of the bk
coefcients and that of the ck coefcients and the wbc(1) statistics, we nd that the ability of
the returns of Pem to predict the returns of P3l, P4l, P5l, and P6l is better than vice versa.13
Combined with the results of Panel A of Table 2, these ndings imply that the returns of
the stocks in which individual investors have greater ownership can be predicted from the
returns of the stocks in which institutional investors have greater ownership and of the
market portfolio.14
3.2. The informational role of financial analysts
Now, we turn our attention to the informational role that nancial analysts play in the
market. Table 3 presents the results of the Granger causality tests for the size-analyst
coverage and the equal-weighted market portfolios. Panel A of Table 3 presents the
estimation results of the bivariate VAR for 12 size-analyst coverage portfolios, Pih
(Portfolio A) versus Pil (Portfolio B), where h and l refer to the highest and lowest analyst
coverage portfolios, respectively, within each size group i. It shows that the sum of the bk
coefcients is smaller than that of the ck coefcients for all size groups. Moreover, based on
the wbc(1) statistics, the null hypothesis that the ability of two portfolios to predict each
other is equal is rejected for ve of six size groups. These ndings are consistent with
Brennan, Jegadeesh, and Swaminathan (1993) that rms followed by more nancial
analysts react faster to market-wide information than do rms followed by fewer nancial
analysts.
Panel B of Table 3 presents the estimation results of the Granger-causality tests for the
portfolios with the highest analyst coverage (i.e., Pih for i=1, 2,y, and 6) and the equalweighted market portfolio, Pem. We nd that the sum of the bk coefcients is smaller than
that of the ck coefcients, and the wbc(1) statistics are signicant at conventional levels for
13
As a robustness test, we also use the returns on the value-weighted market portfolio as another proxy for
market-wide information in our tests. We nd that all conclusions using this alternative proxy remain unchanged.
For brevity, we do not report these results.
14
We also perform similar analyses for the volume-institutional ownership and the equal-weighted market
portfolios. Conclusions from the results using these portfolios are the same as what we obtain from the results
reported in Table 2. For brevity, we do not report these results.
479
Table 3
Vector autoregressions for the size-analyst coverage and the market portfolios.
RA;t aA
K
X
ak RA;tk
k1
RB;t aB
K
X
K
X
bk RB;tk eA;t ;
dk RB;tk eB;t ;
k1
ck RA;tk
k1
K
X
k1
portfolio of size i and analyst coverage j. i=1, 6 refer to the largest and lowest size portfolios, respectively. h and l
refer to the highest and lowest analyst coverage portfolios, respectively, within each size group i. Pem refers to the
equal-weighted portfolios of all NYSE sample rms. The number of lags in each equation is chosen by considering
both the Akaike (1974) information criterion (AIC) and the Schwarz (1978) information criterion (SIC). The wb(K)
and wc(K) statistics obtained from the Wald test are a joint test of the null hypothesis based on the causality
restrictions. The wb(1) and wc(1) statistics obtained from the Wald test are used to test the null hypothesis that
P
P
bk=0 and that
P ck=0,
P respectively. The wbc(1) statistic obtained from the Wald test is used to test the null
hypothesis that bk= ck.
wb(K) or
wc(K)
LHS
variable
(K)
P
bk or
P
ck
wb(1) or
wc(1)
wbc(1)
LHS
variable
(K)
wb(K) or
wc(K)
P
bk or
P
ck
wb(1) or
wc(1)
wbc(1)
Panel A: Pih
R1h,t
(4)
R1l,t
(4)
R2h,t
(8)
R2l,t
(8)
R3h,t
(4)
R3l,t
(4)
(portfolio A)
15.735nnn
8.774n
14.411n
14.725n
66.267nnn
21.432nnn
versus Pil (portfolio B)

0.064
2.291
4.892nn
0.110
6.012nn
0.049
0.895
3.902nn
0.129
6.284nn
0.037
1.425
3.805n
0.154
15.906nnn
R4h,t
R4l,t
R5h,t
R5l,t
R6h,t
R6l,t
(4)
9.645nn
(4) 91.419nnn
(8) 27.396nnn
(8) 204.250nnn
(4) 12.866nn
(4) 98.875nnn
0.078
0.132
0.078
0.220
0.084
0.220
3.300n 0.746
21.305nnn
1.761
14.021nnn
38.445nnn
6.773nnn 7.506nnn
54.391nnn
Panel
R1h,t
Rem,t
R2h,t
Rem,t
R3h,t
Rem,t
B: Pih
(7)
(7)
(5)
(5)
(5)
(5)
(portfolio A)
8.634
45.586nnn
25.732nnn
32.459nnn
38.362nnn
29.815nnn
versus Pem (portfolio B)

0.142
2.819n 5.653nn
0.145
10.698nnn
0.059
0.629
1.995
0.092
5.559nn
0.115
2.627
0.263
0.169
16.092nnn
R4h,t
Rem,t
R5h,t
Rem,t
R5h,t
Rem,t
(4)
8.238n
(4) 46.817nnn
(5) 23.919nnn
(5) 227.316nnn
(5) 61.534nnn
(5)
7.832
0.109
0.080
0.270
0.163
0.480
0.058
2.770n
0.126
9.983nnn
13.626nnn
1.379
37.509nnn
39.187nnn 31.851nnn
4.840nn
Panel
R1l,t
Rem,t
R2l,t
Rem,t
R3l,t
Rem,t
C: Pil
(7)
(7)
(4)
(4)
(4)
(4)
(portfolio A)
15.771nn
41.153nnn
7.775
9.401n
8.290n
38.202nnn
versus Pem (portfolio B)

0.108
2.235
1.011
0.007
0.037
0.090
2.472
2.324
0.031
1.126
0.099
2.873n
1.737
0.005
0.037
R4l,t
Rem,t
R5l,t
Rem,t
R6l,t
Rem,t
(4) 43.064nnn
(4)
3.401
(7) 76.711nnn
(7)
10.854
(9) 181.973nnn
(9) 25.383nnn
0.254
0.036
0.491
0.087
0.623
0.029
16.577nnn 5.615nn
1.009
44.959nnn 28.602nnn
3.847nn
57.604nnn 43.130nnn
0.928
Note:
nnn
, and
nn
P1h versus Pem. Together with the results of Panel A of Table 3, these results suggest that,
because of the low information set-up costs associated with large stocks, some nancial
analysts actively engage in collecting information about them, and thus the price
adjustment of these stocks helps better predict market-wide information. Panel B of
480
Table 3 also shows that the sum of the bk coefcients is greater than that of the ck
coefcients, and the wbc(1) statistics are signicant at conventional levels for P6h versus Pem.
Together with the results of Panel A of Table 3, these results suggest that it is not
worthwhile for some nancial analysts to actively collect information about small stocks
that have high information set-up costs, and thus these stocks tend to respond to marketwide information with a lag. These ndings are consistent with Sant and Zaman (1996) and
Easley, OHara, and Paperman (1998) that analysts do not always provide new
information to the market.
Panel C of Table 3 presents the estimation results of the Granger causality tests for
the portfolios with the lowest analyst coverage (i.e., Pil for i=1, 2,y, and 6) and the
equal-weighted market portfolio, Pem. We nd that the sum of the
is greater
Pbk coefcients
P
than that of the ck coefcients, and the null hypothesis that
bk= ck is rejected at
conventional signicance levels for P4l versus Pem, P5l versus Pem, and P6l versus Pem. This
indicates that the ability of the market portfolios to predict these portfolios is better than
vice versa. Combined with the results of Panel A of Table 3, these ndings imply that rms
followed by fewer nancial analysts tend to respond sluggishly to new market-wide
information.15
3.3. The informational motive for institutional investors
An alternative way to examine the informational role of institutional investors in
relation to market-wide information is to nd a proxy for the informational reasons for
institutional investors to hold their stocks. For this, we rst construct six size and six
volume portfolios as before, and then we further construct two institutional-ownership
portfolios within each size or volume group: a high institutional-ownership portfolio
composed of stocks whose institutional ownership fraction is higher than their market
capitalization proportion, and a low institutional-ownership portfolio composed of stocks
whose institutional ownership fraction is lower than their market capitalization
proportion. The high institutional-ownership portfolio is a proxy for informational
reasons for institutional investors to hold these stocks. Then we perform the Granger
causality tests as before.
Table 4 reports the estimation results of the Granger-causality tests for the sizeinstitutional ownership and the equal-weighted market portfolios. Specically, Panel A of
Table 4 presents the estimation results of the bivariate VAR for 12 size-institutional
ownership portfolios, Pih (portfolio A) versus Pil (portfolio B), where h and l refer to the
high and low institutional-ownership portfolios, respectively, within each size group i. The
wbc(1) statistic is employed to measure the relative ability of the two portfolios in predicting
each other. The results show that for each size group, the sum of the ck coefcients is
greater than that of the bP
Moreover, the wbc(1) statistic, which is used to test
k coefcients.
P
the null hypothesis that bk= ck, is rejected at conventional signicance levels for all
size groups.
Panel B of Table 4 reports the results of the Granger causality tests for the portfolios with
the highest institutional holdings (i.e., Pih for i=1, 2, y , and 6) and the equal-weighted
15
We also use the volume-analyst coverage and the equal-weighted market portfolios to conduct similar
analyses. Since all conclusions drawn from the results using these portfolios are virtually the same as those from
the results reported in Table 3, we do not report these results.
481
Table 4
Vector autoregressions for the size-institutional ownership and the market portfolios.
RA;t aA
K
X
ak RA;tk
k1
RB;t aB
K
X
K
X
bk RB;tk eA;t ;
dk RB;tk eB;t ;
k1
ck RA;tk
k1
K
X
k1
portfolio of size i and institutional-ownership j. i=1, 6 refer to the largest and smallest size portfolios, respectively.
h and l refer to the institutional-ownership portfolios of stocks whose institutional ownership fraction is higher
and lower than their market capitalization proportion in the portfolio, respectively, within each size group i. Pem
refers to the equal-weighted portfolios of all NYSE sample rms. The number of lags in each equation is chosen
by considering both the Akaike (1974) information criterion (AIC) and the Schwarz (1978) information criterion
(SIC). The wb(K) and wc(K) statistics obtained from the Wald test are a joint test of the null hypothesis based on
the causality restrictions.
The wb(1)
P
P and wc(1) statistics obtained from the Wald test are used to test the null
hypothesis that bk=0 and P
that P
ck=0, respectively. The wbc(1) statistic obtained from the Wald test is used to
test the null hypothesis that bk= ck.
wb(K) or
wc(K)
LHS
variable
(K)
P
b or
Pk
ck
wb(1) or
wc(1)
wbc(1)
LHS
variable
(K)
wb(K) or
wc(K)
Panel
R1h,t
R1l,t
R2h,t
R2l,t
R3h,t
R3l,t
A: Pih (portfolio A) versus Pil (portfolio

(4) 13.242nn
0.111
3.494n
nnn
(4) 79.977
0.291
27.233nnn
(5) 13.897nn
0.056
1.162
(5) 108.970nnn
0.418
41.694nnn
(4) 10.800nn
0.111
2.537
(4) 37.719nnn
0.299
33.222nnn
Panel
R1h,t
Rem,t
R2h,t
Rem,t
R3h,t
Rem,t
B: Pih (portfolio A) versus Pem (portfolio B)

(6) 15.964nnn
0.199
8.818nnn 7.469nnn
nnn
(6) 58.533
0.078
3.265n
(6) 25.802nnn
0.176
5.525nn 15.099nnn
(6) 86.013nnn
0.298
29.871nnn
(6) 20.946nnn
0.097
0.890
4.000nn
nnn
nnn
(6) 31.504
0.210
14.068
R4h,t
Rem,t
R5h,t
Rem,t
R5h,t
Rem,t
(8)
(8)
(7)
(7)
(7)
(7)
Panel
R1l,t
Rem,t
R2l,t
Rem,t
R3l,t
Rem,t
C: Pil (portfolio A) versus Pem (portfolio

(7) 41.448nnn
0.052
0.360
(7) 41.376nnn
0.068
1.324
(6) 22.018nnn
0.014
0.021
(6) 41.414nnn
0.173
9.177nnn
(6) 11.003n
0.042
0.189
(6)
0.836
0.019
0.074
R4l,t
Rem,t
R5l,t
Rem,t
R6l,t
Rem,t
(6) 28.707nnn
(6) 10.983n
(5) 84.415nnn
(5) 15.099nnn
(6) 134.777nnn
(6) 16.858nnn
Note:
nnn
nn
, and
B)
13.825nnn R4h,t
R4l,t
11.030nnn R5h,t
R5l,t
12.426nnn R6h,t
R6l,t
B)
0.014
1.142
0.019
(6)
10.133
(6) 92.355nnn
(5)
7.258
(5) 50.313nnn
(6) 13.834nn
(6) 113.322nnn
48.584nnn
79.992nnn
49.461nnn
34.963nnn
92.870nnn
19.057nnn
P
b or
Pk
ck
wb(1) or
wc(1)
wbc(1)
0.054
0.525
0.102
0.359
0.085
0.425
1.139
15.550nnn
nnn
52.938
5.450nn
6.703nnn
nnn
31.591
9.180nnn 17.679nnn
48.837nnn
0.213
0.349
0.458
0.073
0.526
0.085
3.843nn
0.578
20.722nnn
15.626nnn 4.374nn
0.971
26.456nnn 15.475nnn
2.047
0.325
0.013
0.410
0.050
0.530
0.015
11.146nnn 4.800nn
0.059
26.009nnn 10.990nnn
2.017
48.691nnn 34.890nnn
0.482
market portfolio, Pem. Both the relative magnitudes of the sum of the bk coefcients and that
of the ck coefcients and the wbc(1) statistics indicate that the ability of the returns of P1h, P2h,
and P3h to predict the returns of Pem is better than vice versa. Moreover, the results show
482
that the ability of the returns of Pem to predict the returns of P5h and P6h is better than
vice versa.
Panel C of Table 4 reports the results of the Granger causality tests for the portfolios
with the lowest institutional holdings (i.e., Pil for i=1, 2, y , and 6) and the equalweighted market portfolio, Pem. We nd that the ability of the returns of Pem to predict the
returns of P4l, P5l, and P6l is better than vice versa based on the relative magnitudes of the
sum of the bk coefcients and that of the ck coefcients and the wbc(1) statistics. Taken as a
whole, the general pattern observed from the results of Table 4 is virtually the same as that
observed from the results of Table 2. Therefore, the results of Table 4 provide further
evidence on the effect of limited market participation on the informational role played by
institutional investors in the market.16
3.4. Examination of the governance hypothesis
Firms with good corporate governance may produce more public information. This
information production generates more liquidity and trading volume, making their stocks
attractive to both institutional investors and nancial analysts. Because of a large amount
of free information associated with these stocks, they lead other stocks and are
disproportionally owned by institutional investors and covered by nancial analysts.
Built on the above argument, if the observed lead-lag relation between the high and low
institutional-ownership (analyst coverage) portfolios is due to more public information
generated by the high institutional-ownership (analyst coverage) rms with good
governance mechanisms, then this lead-lag relation should disappear or become weaker
once the degree of corporate governance is controlled for each portfolio. Moreover, it is
expected that corporate governance exerts a larger effect on the lead-lag relation between
the high and low institutional-ownership (analyst coverage) portfolios with good corporate
governance than on the lead-lag relation with poor corporate governance. To test the
governance hypothesis, we use the Governance Index constructed by Gompers, Ishii, and
Metrick (2003) to form the governance-institutional ownership and governance-analyst
coverage portfolios and then perform the Granger causality tests for these portfolios.17
Table 5 reports the estimation results of the Granger causality tests for the governanceinstitutional ownership and governance-analyst coverage portfolios. Specically, Panel A
reports the estimation results of the bivariate VAR for 12 governance-institutional
ownership portfolios, Pih (portfolio A) versus Pil (portfolio B), where h and l refer to the
highest and lowest institutional-ownership portfolios, respectively, within each governance
group i. Based on the relative magnitudes of the sum of the bk coefcients and that of the ck
coefcients and the wbc(1) statistic that is used to measure the relative ability of two
portfolios in predicting each other, the ability of the returns of Pih to predict the returns of
Pil, for i=1, 2, 3, and 4, is better than vice versa at the 5% or 10% signicance levels.
Compared to the results in Panel A of Table 2 that the ability of the returns of Pih to
predict the returns of Pil, for i=1, 2, y , and 6, is better than vice versa at the 1%
16
For brevity, we do not report the estimation results of the Granger-causality tests for the volume-institutional
ownership and the equal-weighted market portfolios. They are very similar to the results reported in Table 3.
17
See Gompers, Ishii, and Metrick (2003) for details pertaining to the construction of the Governance Index.
The data of the Governance Index are available only from 1990. During the sample period from 1990 to 2004, we
match 88% of our sample rms with the Governance Index.
483
Table 5
Vector autoregressions for the governance-institutional ownership portfolios and for the governance-analyst
coverage portfolios.
RA;t aA
K
X
ak RA;tk
k1
RB;t aB
K
X
K
X
bk RB;tk eA;t ;
dk RB;tk eB;t ;
k1
ck RA;tk
k1
K
X
k1
portfolio of corporate governance i and institutional-ownership (or analyst coverage) j. i=1, 6 refer to the largest
and smallest Governance Index portfolios, respectively. h and l refer to the highest and lowest institutionalownership (or analyst coverage) portfolios, respectively, within each governance group i. A large Governance
Index refers to poor governance (dictatorship portfolio), while a small Governance Index refers to good
governance (democracy portfolio). The number of lags in each equation is chosen by considering both the Akaike
(1974) information criterion (AIC) and the Schwarz (1978) information criterion (SIC). The wb(K) and wc(K)
statistics obtained from the Wald test are a joint test of the null hypothesis based on the causalityP
restrictions. The
wb(1) and wc(1) statistics obtained from the Wald test are used to test the null hypothesis that bk=0 and that
P
c =0, respectively. The wbc(1) statistic obtained from the Wald test is used to test the null hypothesis that
P k P
bk= ck.
wb(K) or
wc(K)
LHS
variable
(K)
P
bk or
P
ck
wb(1) or
wc(1)
wbc(1)
LHS
variable
(K)
wb(K) or
wc(K)
P
bk or
P
ck
wb(1) or
wc(1)
Panel A: Pih (portfolio A) versus Pil (portfolio B) for the

2.291
0.037
1.085
6.107nn
R1h,t (4)
nnn
nnn
R1l,t (4) 30.024
0.214
19.240
R2h,t (4)
4.821
0.083
3.896nn 4.448nn
nnn
0.203
27.980nnn
R2l,t (4) 36.869
R3h,t (7) 16.776nn
0.118
5.436nn
2.933n
nnn
nnn
R3l,t (7) 207.916
0.244
28.957
governance-institutional ownership portfolios

R4h,t (4)
3.542
0.004
0.008
R4l,t (4) 18.117nnn
0.116
14.681nnn
R5h,t (8) 20.429nnn
0.027
0.179
R5l,t (8) 34.708nnn
0.111
5.007nn
R6h,t (7)
11.186
0.037
0.548
R6l,t (7) 35.570nnn
0.132
6.460nn
Panel B: Pih (portfolio A) versus Pil (portfolio B) for the

R1h,t (5) 14.456nn
0.019
0.216
3.998nn
nnn
nnn
R1l,t (5) 25.235
0.121
7.389
R2h,t (7) 16.882nn
0.063
2.353
5.284nn
nnn
nn
R2l,t (7) 20.392
0.133
4.488
R3h,t (6)
9.822
0.037
0.661
5.315nn
nnn
nnn
R3l,t (6) 18.845
0.135
7.832
governance-analyst coverage portfolios

R4h,t (8)
3.810
0.022
0.345
R4l,t (8) 50.354nnn
0.221
21.664nnn
R5h,t (8) 51.609nnn
0.058
1.833
R5l,t (8) 28.529nnnn
0.226
11.617nnn
R6h,t (8) 20.250nnn
0.039
0.585
R6l,t (8) 22.651nnn
0.105
4.048nn
Note:
nnn
nn
, and
wbc(1)
4.177nn
0.986
1.274
3.023n
3.250n
0.164
signicance level, the results of Panel A of Table 5 therefore imply that corporate
governance exerts some effect on the lead-lag relation between the high and low
institutional-ownership portfolios with poor corporate governance and makes this lead-lag
relation become weaker. However, corporate governance exerts a substantial effect on the
lead-lag relation between the high and low institutional-ownership portfolios with good
corporate governance and makes this lead-lag relation disappear.
Panel B of Table 5 reports the estimation results of the bivariate VAR for 12 governanceanalyst coverage portfolios, Pih (portfolio A) versus Pil (portfolio B), where h and l refer to the
highest and lowest analyst coverage portfolios, respectively, within each governance group i.
484
Based on the relative magnitudes of the sum of the bk coefcients and that of the ck coefcients
and the wbc(1) statistic, the ability of the returns of Pih to predict the returns of Pil, for i=1,
2, y , and 5, is better than vice versa at the 5% or 10% signicance levels. Compared to the
results in Panel A of Table 3, the results of Panel B of Table 5 imply that corporate governance
exerts some effect on the lead-lag relation between the high and low analyst coverage
portfolios with poor corporate governance and makes this lead-lag relation become weaker.
However, corporate governance exerts a substantial effect on the lead-lag relation between the
high and low analyst coverage portfolios with good corporate governance and makes this leadlag relation disappear.
Overall, the results of Table 5 imply that some of the observed lead-lag relations in Table 2
and 3 are attributable to the public information generated by the high institutional-ownership
and analyst coverage rms with good corporate governance mechanisms.
3.5. The complementary and substitution effects between high institutional and high analyst
portfolios
Table 6 reports the estimation results of four regression Eqs. (3)(6) used to investigate
the complementary and substitution effects between high institutional portfolios and high
analyst portfolios in predicting market returns. Specically, Table 6 reports D1 and D2
which is the measure of the difference in the R-squares between Eqs. (3) and (4) and that
between Eqs. (5) and (6), respectively. If there is a complementary (substitution) effect, the
difference in the R-squares between Eqs. (3) and (4) should be less (greater) than that
between Eqs. (5) and (6).
Panel A of Table 6 reports the results using the returns of the high and low institutionalownership portfolios and the returns of the high analyst coverage portfolios within the
high and low institutional-ownership groups to predict the equal-weighted market returns.
Panel A shows that D1 is less than D2, indicating that high analyst portfolios complement
high institutional portfolios in predicting the equal-weighted market returns.
Panel B of Table 6 reports the results using the returns of the high and low analyst
coverage portfolios and the returns of the high institutional-ownership portfolios within
the high and low analyst coverage groups to predict the equal-weighted market returns.
Similar to what we observe in Panel A of Table 6, Panel B of Table 6 shows that D1 is less
than D2, indicating that high institutional portfolios complement high analyst portfolios in
predicting the equal-weighted market returns. Overall, the results of Table 6 indicate that
high institutional portfolios and high analyst portfolios complement each other in
predicting the equal-weighted market returns.18
3.6. On the systematic difference between institutional investors and financial analysts
Table 7 reports the estimation results of Eq. (7) that compare the predictive power of the
highest institutional-ownership with that of the highest analyst coverage portfolios with
similar size in predicting the value and growth portfolios.19 The wbc(1) statistics are used to
18
We also estimate Eqs. (3)(6) by excluding the lagged market returns. The results again show that high
institutional portfolios and high analyst portfolios complement each other in predicting market returns.
19
The results using the highest institutional-ownership versus highest analyst coverage portfolios with similar
trading volume are similar to those reported in Table 7.
485
Table 6
Regressions for the complementary and substitution effects.
The following regressions are estimated to examine the complementary and substitution effects between
institutional investors and nancial analysts in predicting the market returns for the sample period from January
1983 to December 2004:
Rm;t am
K
X
bk Rm;tk
k1
Rm;t am
K
X
K
X
bk Rm;tk
K
X
k1
K
X
lk RB;tk em;t ;
jk RC;tk em;t ;
dk RD;tk em;t ;
k1
bk Rm;tk
k1
Rm;t am
gk RA;tk em;t ;
k1
k1
Rm;t am
K
X
K
X
k1
bk Rm;tk
K
X
k1
where RA,t, RB,t, RC,t and RD,t are the daily returns on the portfolios A, B, C, and D, respectively, and Rm,t is the
daily returns on the market portfolio. Pi refers to an equal-weighted portfolio of institutional-ownership or
analyst coverage i. i=1, 6 refer to the highest and lowest institutional ownership or analyst coverage portfolios. Pij
refers to an equal-weighted portfolio of institutional ownership i and analyst coverage j. i=1, 6 refer to the highest
and lowest institutional ownership portfolios, respectively. h and l refer to the highest and lowest analyst coverage
portfolios, respectively, within each institutional ownership group i. The analyst coverageinstitutional ownership
portfolios are dened analogously. Pem refers to the equal-weighted portfolios of all NYSE sample rms. The
number of lags in each equation is chosen considering both the Akaike (1974) information criterion (AIC) and the
Schwarz (1978) information criterion (SIC). R2 is the coefcient of determinant. D1 (D2) is the difference in R2
between equations (3) and (4) ((5) and (6)).
Equation
(3)
(4)
(5)
(6)
Panel A: Portfolio A (the highest institutional ownership portfolio, P1), Portfolio B (the lowest institutional ownership
portfolio, P6), Portfolio C (the institutional ownership-analyst coverage portfolio, P1h), Portfolio D (the institutional
ownership-analyst coverage portfolio, P6h), and Market Portfolio (Pem)
R2
3.575%
3.400%
3.782%
3.287%
D1 or D2
0.175%
0.495%
Complementarity or substitutability
Complementarity
Panel B: Portfolio A (the highest analyst coverage portfolio, P1), Portfolio B (the lowest analyst coverage portfolio,
P6), Portfolio C (the analyst coverageinstitutional ownership portfolio, P1h), Portfolio D (the analyst coverageinstitutional ownership portfolio, P6h), and Market Portfolio (Pem)
R2
3.325%
3.285%
3.461%
3.288%
D1 or D2
0.040%
0.173%
Complementarity or substitutability
Complementarity
Note:
nnn
nn
, and
P
P
test the null hypothesis that bk= ck. In Panel A, the returns of the value portfolios are
used as the predicted variables (i.e., RA,t), and the result shows that the sum of the bk
coefcients is greater
P than
P that of the ck coefcients, and the wbc(1) statistics reject the null
hypothesis that bk= ck at conventional signicance levels for P2hi versus P2ha, P3hi
versus P3ha, and P4hi versus P4ha. This provides evidence that the ability of the returns of
486
Table 7
Regression for the ability of institutional investors vs. nancial analysts to predict the returns of the value and
growth stocks.
The following regression is estimated to examine the ability of the highest institutional-ownership versus highest
analyst coverage portfolios with similar size to predict the value and growth portfolios for the sample period from
January 1983 to December 2004:
RA;t aA
K
X
ak RA;tk
k1
K
X
bk RB;tk
k1
K
X
ck RC;tk eA;t ;
k1
where RA,t, RB,t, and RC,t are the daily returns on the portfolios A, B, and C, respectively. Pv and Pg refer to an
equal-weighted portfolio of value stocks and that of growth stocks, respectively. Pihi refers to an equal-weighted
portfolio of size i and the highest institutional-ownership and Piha refers to an equal-weighted portfolio of size i
and the highest analyst coverage. i=1, 6 refer to the largest and smallest size portfolios, respectively. The number
of lags in Eq. (1) is chosen by considering both the Akaike (1974) information criterion (AIC) and the Schwarz
(1978) information criterion (SIC). The wb(K) and wc(K) statistics obtained from the Wald test are a joint test of the
null hypothesis that bk=0 for all k and that ck=0 for all k, respectively. The wb(1) and wc(1) statistics obtained
P
P
from the Wald test are used to test the null hypothesis that bk=0 and that ck=0, respectively. The wbc(1)
P
P
2
statistic obtained from the Wald test is used to test the null hypothesis that bk= ck. R is the adjusted
coefcient of determinant.
Pihi and Piha
P1hi and P1ha
P2hi and P2ha
P3hi and P3ha
P4hi and P4ha
P5hi and P5ha
P6hi and P6ha
Panel A: Ability of Pihi (portfolio B) versus Piha (portfolio C) to predict Pv (portfolio A)

Lag length K
4
4
4
4
7
wb(K)
0.613
14.466nnn
9.067n
12.760nn
15.003nn
[p-Value]
[0.962]
[0.006]
[0.059]
[0.013]
[0.036]
P
bk
0.046
0.206
0.178
0.168
0.053
wb(1)
0.508
4.183nn
5.247nn
4.512nn
0.469
[p-Value]
[0.476]
[0.041]
[0.022]
[0.034]
[0.494]
wc(K)
12.181nn
3.472
5.276
4.392
5.475
[p-Value]
[0.016]
[0.482]
[0.260]
[0.356]
[0.602]
P
ck
0.136
0.127
0.148
0.103
0.063
4.718nn
1.584
3.243n
1.767
0.292
wc(1)
[p-Value]
[0.030]
[0.208]
[0.072]
[0.184]
[0.589]
wbc(1)
2.469
2.980n
4.928nn
3.663n
0.455
[p-Value]
[0.116]
[0.084]
[0.026]
[0.056]
[0.500]
2
0.061
0.070
0.056
0.059
0.059
R
7
7.356
[0.393]
0.023
0.107
[0.744]
2.459
[0.930]
0.074
0.433
[0.510]
0.106
[0.745]
0.055
Panel B: Ability of Pihi (portfolio B) versus Piha (portfolio C) to predict Pg (portfolio A)

Lag length K
6
6
6
6
7
wb(K)
6.040
29.609nnn
34.620nnn
27.164nnn
32.511nnn
[p-Value]
[0.419]
[0.000]
[0.000]
[0.000]
[0.000]
P
0.018
0.107
0.158
0.162
0.096
bk
wb(1)
0.191
6.108nn
11.686nnn
11.962nnn
5.533nn
[p-Value]
[0.662]
[0.013]
[0.001]
[0.001]
[0.019]
33.878nnn
6.707
5.238
7.779
8.390
wc(K)
[p-Value]
[0.000]
[0.349]
[0.514]
[0.255]
[0.299]
P
ck
0.135
0.021
0.035
0.045
0.014
wc(1)
14.765nnn
0.182
0.453
0.840
0.042
[p-Value]
[0.000]
[0.670]
[0.501]
[0.359]
[0.838]
wbc(1)
5.153nn
1.031
4.683nn
5.929nn
0.714
[p-Value]
[0.023]
[0.310]
[0.030]
[0.015]
[0.398]
2
0.135
0.130
0.122
0.125
0.123
R
6
18.042nnn
[0.006]
0.102
7.990nnn
[0.005]
7.981
[0.239]
0.029
0.373
[0.541]
3.810nn
[0.051]
0.111
Note:
nnn nn
, and
487
the highest institutional-ownership portfolios to predict the returns of the value portfolios
is better than that of the returns of the highest analyst coverage portfolios.
Panel B of Table 7 reports the results when the returns of the growth portfolios are used
as the predicted variables (i.e., RA,t). The results show that the sum of the bk coefcients is
greater
P thanPthat of the ck coefcients, and the wbc(1) statistics reject the null hypothesis
that bk= ck at conventional signicance levels for P3hi versus P3ha, P4hi versus P4ha,
and P6hi versus P6ha that the sum of the ck coefcients is greater than P
that ofPthe bk
coefcients, and the wbc(1) statistics reject the null hypothesis that
bk= ck at
conventional signicance levels only for P1hi versus P1ha. These observations suggest that
the ability of the returns of the highest institutional-ownership portfolios to predict the
returns of the growth portfolios is still better than that of the returns of the highest analyst
coverage portfolios. As such, we do not nd any signicant evidence for the hypothesis of
the systematic difference between institutional investors and nancial analysts in predicting
the returns of stocks with different characteristics such as value and growth portfolios.
When we employ various portfolios with other characteristics, such as large and small
sizes, high and low volumes, high and low volatilities, old and young stocks, we do not nd
any signicant evidence in favor of the systematic difference either. Instead, we nd
evidence that institutional investors tend to predict the returns of stocks with different
characteristics better than nancial analysts.20
3.7. The relative speed of the diffusion of good and bad market-wide news across investors
Table 8 reports the estimates of Equation (8). Panel A of Table 8 reports the results for
the portfolios with the highest (Pih) and lowest (Pil) institutional holdings in six size
DN
groups. The dependent variable is Pil for i=1, 2, y , and 6. We nd that bUP
il;0 obil;0 , and
DN
the null hypothesis that bUP
i0 bi0 is rejected at the 1% level for all size groups. We also
PK
P
PK
PK
K
DN
UP
DN
nd that k1 bUP
is
ik 4
k1 bik ; and the null hypothesis that
k1 bik
k1 bik
21
rejected at least at the 5% level in all size groups. These ndings suggest that the
portfolios with the lowest institutional holdings respond more sluggishly to good marketwide news than to bad market-wide news.
Similarly, Panel B of Table 8 reports the results for the portfolios with the highest (Pih)
and lowest (Pil) analyst coverage in six size groups. Again, the left-hand-side variable of the
20
Several observations for stocks with other characteristics are noted. First, the comparison of the ability of the
returns of the highest institutional-ownership portfolios versus the highest analyst coverage portfolios to predict
the returns of the large size portfolios exhibits no signicant difference, and the ability of the returns of the highest
institutional-ownership portfolios to predict the returns of the small size portfolios is better than that of the
returns of the highest analyst coverage portfolios. Second, the ability of the returns of the highest institutionalownership portfolios to predict both the returns of the high volume portfolios and the returns of the low volume
portfolios is better than that of the returns of the highest analyst coverage portfolios. Third, the ability of the
returns of the highest institutional-ownership portfolios to predict both the returns of the high volatility portfolios
and the returns of the low volatility portfolios is better than that of the returns of the highest analyst coverage
portfolios. Fourth, the ability of the returns of the highest institutional-ownership portfolios to predict both the
returns of the old stock portfolios and the returns of the young stock portfolios is better than that of the returns of
the highest analyst coverage portfolios. We do not report these results for brevity.
21
The observation that the sum of the lagged bDN
il;k is signicantly negative suggests an overreaction of the
portfolios with the lowest institutional holdings to bad market-wide news corrected in the following days in
contrast to the partially delayed reaction to good market-wide news (see also McQueen, Pinegar, and Thorley,
1996).
488
Table 8
Asymmetric regression based on the sign of portfolio returns.
The following regression is estimated to examine the asymmetric response of the returns of one portfolio to positive
and negative returns of the other portfolio for the sample period from January 1983 to December 2004:
RB;t aB
K
X
bUP
B;k RA;tk DA;tk
K
X
k0
bDN
B;k RA;tk 1DA;tk eB;t ;
k0
where RA,t and RB,t are the daily returns on the portfolios A and B, respectively, and D
A;t is a dummy variable and takes
on a value of one if RA,t is positive and zero otherwise. Pij refers to an equal-weighted portfolio of size i and institutionalownership or analyst coverage j. i=1, 6 refer to the largest and smallest size portfolios, respectively. h and l refer to the
highest and lowest institutional-ownership or analyst coverage portfolios, respectively, within each size group i. The
number of lags in the equation is chosen by considering both the Akaike (1974) information criterion (AIC) and the
P
UP
Schwarz (1978) information criterion (SIC). The w(1) test statistic is used to test the null hypothesis that K
k1 bik 0
PK
DN
UP
DN
and that k1 bik 0: The w1(1) test statistic is used to test the null hypothesis that bi0 bi0 : The w2(1) test statistic
P
PK
UP
DN
is used to test the null hypothesis that K
k1 bik
k1 bik :
R1l,t
LHS variable
Panel A: Size-institutional ownership

Lag length K
4
0.531nnn
bUP
il;0
(29.261)
nnn
0.658
bDN
il;0
w1(1)
[p-Value]
PK
UP
k1 bil;k
w(1)
[p-Value]
PK
DN
k1 bil;k
w(1)
[p-Value]
w2(1)
[p-Value]
R2l,t
R3l,t
R4l,t
portfolios (Pih=portfolio A and Pil=portfolio B)

4
3
4
4
0.521nnn
0.530nnn
0.532nnn
0.552nnn
Note:
nnn nn
, and
R6l,t
4
0.447nnn
(25.029)
0.640nnn
(24.700)
0.649nnn
(23.897)
0.670nnn
(21.421)
0.707nnn
(14.074)
0.595nnn
(21.955)
9.727nnn
[0.002]
0.077
(24.747)
11.456nnn
[0.001]
0.058
(21.741)
8.927nnn
[0.003]
0.074
(28.479)
22.430nnn
[0.000]
0.040
(24.372)
19.262nnn
[0.000]
0.068
(19.484)
9.201nnn
[0.002]
0.285
4.799nn
[0.028]
0.139
3.769n
[0.052]
0.075
8.332nnn
[0.004]
0.028
2.469
[0.116]
0.086
8.303nnn
[0.004]
0.090
33.240nnn
[0.000]
0.053
4.836nn
[0.028]
6.171nn
[0.013]
5.036nn
[0.025]
6.696nnn
[0.010]
3.164n
[0.075]
6.239nn
[0.012]
4.573nn
[0.032]
5.582nn
[0.018]
3.640n
[0.056]
7.731nnn
[0.005]
1.744
[0.187]
11.769nnn
[0.001]
1
0.372nnn
2
0.393nnn
(14.685)
0.496nnn
(14.227)
0.553nnn
Panel B: Size-analyst coverage portfolios (Pih=portfolio A and Pil=portfolio B)

Lag length K
4
2
2
1
nnn
nnn
nnn
nnn
0.781
0.695
0.658
0.442
bUP
il;0
(26.564)
(20.336)
(17.756)
(17.006)
0.896nnn
0.738nnn
0.811nnn
0.607nnn
bDN
il;0
w1(1)
[p-Value]
PK
UP
k1 bil;k
w(1)
[p-Value]
PK
DN
k1 bil;k
w(1)
[p-Value]
w2(1)
[p-Value]
R5l,t
(19.473)
2.939n
[0.086]
0.011
(23.154)
0.614
[0.433]
0.011
(19.429)
5.229nn
[0.022]
0.105
(16.714)
14.866nnn
[0.000]
0.038
(10.848)
6.304nn
[0.012]
0.035
(17.798)
14.270nnn
[0.000]
0.161
0.178
[0.731]
0.210
0.090
[0.764]
0.016
6.460nn
[0.011]
0.121
3.082n
[0.079]
0.099
1.022
[0.312]
0.179
32.964nnn
[0.000]
0.065
17.154nnn
[0.000]
9.904nnn
[0.002]
0.105
[0.746]
0.131
[0.717]
2.767n
[0.096]
4.792nn
[0.029]
13.425nnn
[0.000]
2.197
[0.138]
4.477nn
[0.034]
2.598
[0.107]
3.892nn
[0.049]
3.764n
[0.052]
489
DN
regression is Pil for i=1, 2, y , and 6. The observation that bUP
il;0 obil;0 ; with the rejection
DN
of the null hypothesis that bUP
at conventional signicance levels, and that
i0 bi0
P
PK
PK
K
UP
DN
UP
k1 bik 4
k1 bik ; with the rejection of the null hypothesis that
k1 bik
PK
DN
k1 bik at conventional signicance levels, can be found in the rst, third, and sixth
size groups. These ndings suggest that good market-wide news travels more slowly across
investors than does bad market-wide news.22
3.8. The relative speed of the diffusion of good and bad news during the business cycle
Table 9 reports estimates of Equation (9). Panel A reports the estimation results for the
portfolios with the highest (Pih) and lowest (Pil) institutional holdings in six size groups.
Again, the left-hand-side variable of the regression is Pil for i=1, 2, y , and 6. We nd
that bUP-EXP
obDN-EXP
and the w1(1) statistic, which is used to test the null hypothesis that
i0
i0
UP-EXP
DN-EXP
bi0
; is rejected at conventional signicance levels for all size groups. We
bi0
P
P
UP-EXP
DN-EXP
also nd that K
4 K
and the w2(1) statistic, which is used to test the
k1 bik
k1 bik
PK
P
K
UP-EXP
DN-EXP
null hypothesis that k1 bik
k1 bik
; is rejected at conventional signicance
levels in ve of six size groups. These ndings suggest that good market-wide news diffuses
more slowly across investors than does bad market-wide news during periods of NBERdated expansions.
Panel B of Table 9 reports the results for the portfolios with the highest (Pih) and lowest
(Pil) analyst coverage in six size groups. The results in Panel B of Table 9 show that
bUP-EXP
obDN-EXP
; and the null hypothesis that bUP-EXP
bDN-EXP
is rejected at convenil;0
il;0
i0
i0
P
PK
K
UP-EXP
DN-EXP
4 k1 bik
; and the null hypothesis
tional signicance levels, and that k1 bik
PK
PK
UP-EXP
DN-EXP
that k1 bik
k1 bik
is rejected at conventional signicance levels in the rst
and third size groups. These ndings suggest that during periods of NBER-dated
expansions, good market-wide news travels more slowly across investors than does bad
market-wide news. The results in Panel B yield no signicant evidence of the asymmetric
speed of the diffusion of good and bad market-wide news across investors during periods
of NBER-dated contractions.
4. Concluding remarks
Limited market participation implies that the degree of institutional investors and
nancial analysts engaging in information-gathering activities depends on the information
set-up cost. Institutional investors and nancial analysts actively engage in collecting
information about stocks with low information set-up costs, and thus the price adjustment
of these stocks helps better predict market-wide information. On the other hand,
institutional investors and nancial analysts have less incentive to collect information
about stocks with high information set-up costs, and thus the price adjustment of these
stocks has little predictive power for market-wide information. Our empirical results
provide evidence in favor of these hypotheses. Moreover, we nd also that the observed
lead-lag relation between the high and low institutional-ownership (analyst coverage)
22
In Tables 8 and 9, we do not report the results for the volume-institutional ownership and volume-analyst
coverage portfolios since the results using these portfolios yield the same conclusions.
490
Table 9
Asymmetric regression based on the sign of portfolio returns and the state of the macroeconomy.
The following regression is estimated to examine the asymmetric response of the returns of one portfolio to
positive and negative returns of the other portfolio conditional on the state of the macroeconomy for the sample
period from January 1983 to December 2004:
RB;t ail
K
X
EXP
bUP-EXP
RA;tk D
B;k
A;tk Dtk
k0
M
X
K
X
EXP
bDN-EXP
RA;tk 1D
B;k
A;tk Dtk
k0
EXP
bUP-CON
RA;tm D
B;m
A;tm 1Dtm
m0
M
X
EXP
bDN-CON
RA;tm 1D
B;m
iA;tm 1Dtm eB;t ;
m0
9
D
A;t
is a dummy variable and

where RA,t and RB,t are the daily returns of the portfolios A and B, respectively,
is
a
dummy
variable
and takes on a value
takes on a value of one if RA,t is positive and zero otherwise, and DEXP
t
of one during an NBER-dated expansion and zero otherwise. Pij refers to an equal-weighted portfolio of size i and
institutional-ownership or analyst coverage j. i=1, 6 refer to the largest and smallest size portfolios, respectively. h
and l refer to the highest and lowest institutional-ownership or analyst coverage portfolios, respectively, within
each size group i. The number of lags in the equation is chosen by considering both the Akaike (1974) information
criterion (AIC) and the Schwarz (1978) information criterion (SIC). The w(1) test statistic is used to test the
null hypothesis that the sum of the lagged coefcients is equal to zero. The w1(1) test statistic is used to test the null
hypothesis that bUP-EXP
bDN-EXP
and that bUP-CON
bDN-CON
: The w2(1) test statistic is used to test the null
i0
i0
i0
Pi0K
PK
P
P
UP-EXP
DN-EXP
UP-CON
DN-CON
hypothesis that k1 bik
k1 bik
and that K
b
K
:
k1 ik
k1 bik
LHS variable
R1l,t
R2l,t
R3l,t
R4l,t
R5l,t
Panel A: Size-institutional ownership portfolios (Pih=portfolio A and Pil=portfolio B)

Lag length K
3
4
3
4
1
0.478nnn
0.489nnn
0.499nnn
0.468nnn
0.520nnn
bUP-EXP
il;0
(24.646)
(19.565)
(17.259)
(15.558)
(12.088)
nnn
nnn
nnn
nnn
nnn
0.635
0.649
0.651
0.655
0.684
bDN-EXP
il;0
w1(1)
[p-Value]
PK
UP-EXP
k1 bil;k
w(1)
[p-Value]
PK
DN-EXP
k1 bil;k
w(1)
[p-Value]
w2(1)
[p-Value]
Lag length M
bUP-CON
il;0
bDN-CON
il;0
w1(1)
[p-Value]
PK
UP-CON
k1 bil;m
w(1)
[p-Value]
PK
DN-CON
k1 bil;m
R6l,t
5
0.480nnn
(10.889)
0.653nnn
(15.416)
8.580nnn
[0.003]
0.050
(20.800)
14.929nnn
[0.000]
0.051
(16.751)
9.206nnn
[0.002]
0.066
(18.862)
23.852nnn
[0.000]
0.035
(17.654)
14.473nnn
[0.000]
0.010
(16.487)
6.514nn
[0.011]
0.369
2.693
[0.101]
0.140
4.558nn
[0.033]
0.106
7.238nnn
[0.007]
0.093
1.549
[0.213]
0.097
0.123
[0.725]
0.046
20.254nnn
[0.000]
0.033
3.378n
[0.066]
3.701n
[0.054]
4
0.709nnn
8.869nnn
[0.003]
10.589nnn
[0.001]
1
0.616nnn
2.975n
[0.085]
5.502nn
[0.019]
1
0.617nnn
3.706n
[0.054]
4.676nn
[0.031]
1
0.651nnn
1.135
[0.287]
1.142
[0.285]
1
0.652nnn
0.417
[0.519]
11.733nnn
[0.001]
1
0.443nnn
(19.663)
0.752nnn
(16.988)
0.608nnn
(27.424)
0.635nnn
(25.718)
0.702nnn
(18.364)
0.726nnn
(10.823)
0.476nnn
(17.283)
0.428
[0.513]
0.113
(17.8269)
0.023
[0.881]
0.021
(22.705)
0.192
[0.661]
0.035
[24.244]
1.464
[0.226]
0.004
(25.076)
2.017
[0.156]
0.014
(10.632)
0.256
[0.613]
0.119
2.926n
[0.087]
0.053
0.100
[0.752]
0.025
0.635
[0.425]
0.011
0.023
[0.879]
0.028
0.301
[0.583]
0.033
11.902nnn
[0.001]
0.049

w(1)
[p-Value]
w2(1)
[p-Value]
0.750
[0.387]
2.831n
[0.092]
0.478
[0.489]
0.003
[0.957]
0.139
[0.710]
0.708
[0.400]
1.147
[0.284]
0.360
[0.548]
Panel B: Size-analyst coverage portfolios (Pih=portfolio A and Pil=portfolio B)

Lag length K
4
3
1
1
0.724nnn
0.600nnn
0.563nnn
0.395nnn
bUP-EXP
il;0
(22.572)
(16.638)
(16.215)
(11.446)
0.892nnn
0.690nnn
0.757nnn
0.607nnn
bDN-EXP
il;0
w1(1)
[p-Value]
PK
UP-EXP
k1 bil;k
w(1)
[p-Value]
PK
DN-EXP
k1 bil;k
w(1)
[p-Value]
w2(1)
[p-Value]
Lag length M
bUP-CON
il;0
bDN-CON
il;0
w1(1)
[p-Value]
PK
UP-CON
k1 bil;m
w(1)
[p-Value]
PK
DN-CON
k1 bil;m
w(1)
[p-Value]
w2(1)
[p-Value]
Note:
nnn
nn
, and
491
1.385
[0.239]
1.238
[0.266]
1.508
[0.219]
1.307
[0.253]
1
0.294nnn
1
0.385nnn
(9.453)
0.438nnn
(9.774)
0.560nnn
(15.944)
4.566nn
[0.033]
0.007
(28.882)
3.283n
[0.070]
0.054
(12.327)
5.469nn
[0.019]
0.105
(13.294)
17.519nnn
[0.000]
0.067
(7.541)
5.996nn
[0.014]
0.089
(15.756)
12.492nnn
[0.000]
0.116
0.045
[0.832]
0.244
1.298
[0.255]
0.057
8.027nnn
[0.005]
0.111
6.471nn
[0.011]
0.136
3.299n
[0.069]
0.258
16.507
[0.000]
0.070
18.906
[0.000]
11.379nnn
[0.001]
1
0.984nnn
1.226
[0.268]
0.001
[0.969]
1
0.979nnn
1.971
[0.160]
4.140nn
[0.042]
1
0.970nnn
20.013nnn
[0.000]
2.182
[0.140]
1
0.517nnn
5.774nn
[0.016]
2.430
[0.119]
1
0.487nnn
6.057nn
[0.014]
0.940
[0.332]
3
0.408nnn
(20.268)
0.899
(21.229)
0.957nnn
(17.590)
0.946nnn
(14.711)
0.628nnn
(13.404)
0.635nnn
(10.305)
0.529nnn
(11.723)
0.677
[0.411]
0.028
(22.577)
0.112
[0.738]
0.014
(18.901)
0.088
[0.767]
0.013
(15.300)
3.705n
[0.054]
0.023
(15.111)
6.011nn
[0.014]
0.051
(12.599)
3.275n
[0.070]
0.203
0.460
[0.498]
0.015
0.096
[0.757]
0.103
0.062
[0.803]
0.040
0.468
[0.494]
0.008
2.837n
[0.092]
0.014
16.144nnn
[0.000]
0.156
0.094
[0.759]
0.030
[0.862]
5.039nn
[0.025]
2.950n
[0.086]
0.632
[0.426]
0.126
[0.723]
0.047
[0.829]
0.322
[0.570]
0.156
[0.693]
1.408
[0.235]
7.710nnn
[0.005]
0.363
[0.547]
portfolios is partially attributed to more public information generated by the high

institutional-ownership (analyst coverage) rms with good governance mechanisms.
We also explore other issues associated with the informational role that institutional
investors and nancial analysts play in the market. We investigate whether high
institutional portfolios and high analyst portfolios complement or substitute each other
in predicting market returns. We nd that there is a complementary effect between high
institutional portfolios and high analyst portfolios in predicting market returns. We also
investigate whether there is any systematic difference between high institutional portfolios
and high analyst portfolios in predicting the returns of stocks with different characteristics.
We do not nd any strong evidence for the systematic difference. Instead, we nd that the
returns of high institutional portfolios tend to predict the returns of stocks with different
characteristics better than those of high analyst portfolios.
492
As for the relative speed of the diffusion of good and bad market-wide news across
securities, our results conrm the nding of McQueen, Pinegar, and Thorley (1996) that
good market-wide news travels more slowly across securities than does bad market-wide
news. Moreover, we nd that this asymmetric speed of the diffusion of good and bad
market-wide news across securities primarily occurs during periods of NBER-dated
expansions.
One interesting nding obtained from our empirical analyses is that the returns of some
specic portfolios such as the portfolios with larger market capitalization and the highest
institutional ownership lead the returns on the market portfolio. However, it is not clear
whether investors could prot from observing the price movements of stocks with these
characteristics to devise their trading strategies once transaction costs are taken into
account. Another important issue unresolved in our study is what drives the observation
that institutional investors and nancial analyst complement each other in predicting
market returns. It is possible that analyst coverage lowers the marginal cost of information
production to institutions and thus institutional investigation of rms with high analyst
coverage is greater, resulting in higher information content for their returns. A more
rigorous study of these unresolved issues is warranted for future research.
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The Informational Role of Institutional Investors and Financial Analysts in The Market

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Journal of Financial Markets 14 (2011) 465493

The informational role of institutional investors and

W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493

W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493

W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493

coverage portfolios to investigate the informational role played by institutional investors

W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493

asymmetric delayed response occurs primarily during periods of NBER-dated expansions.

W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493

W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493

Size-institutional ownership portfolios

Volume-institutional ownership portfolios

Std. dev. (%)

W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493

Volume-analyst coverage portfolios

Std. dev. (%)

denote signicance at the 1%, 5%, and 10% levels, respectively.

W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493

2.3. Empirical framework

W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493

W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493

Therefore, it is safe to dene D

W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493

is a dummy variable and takes on a value of one during an NBER-dated

W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493

(portfolio A) versus Pil

C: Pil (portfolio A) versus Pem (portfolio B)

versus Pem (portfolio

denote signicance at the 1%, 5%, and 10% levels, respectively.

W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493

W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493

versus Pil (portfolio B)

versus Pem (portfolio B)

versus Pem (portfolio B)

denote signicance at the 1%, 5%, and 10% levels, respectively.

W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493

W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493

A: Pih (portfolio A) versus Pil (portfolio

B: Pih (portfolio A) versus Pem (portfolio B)

C: Pil (portfolio A) versus Pem (portfolio

denote signicance at the 1%, 5%, and 10% levels, respectively.

W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493

W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493

Panel A: Pih (portfolio A) versus Pil (portfolio B) for the

governance-institutional ownership portfolios

Panel B: Pih (portfolio A) versus Pil (portfolio B) for the

governance-analyst coverage portfolios

denote signicance at the 1%, 5%, and 10% levels, respectively.

W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493

W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493

denote signicance at the 1%, 5%, and 10% levels, respectively.

W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493

P1hi and P1ha

P2hi and P2ha

P3hi and P3ha

P4hi and P4ha

P5hi and P5ha

P6hi and P6ha

Panel A: Ability of Pihi (portfolio B) versus Piha (portfolio C) to predict Pv (portfolio A)

Panel B: Ability of Pihi (portfolio B) versus Piha (portfolio C) to predict Pg (portfolio A)

denote signicance at the 1%, 5%, and 10% levels, respectively.

W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493

W.-I. Chuang, B.-S. Lee / Journal of Financial Markets 14 (2011) 465493