Journal of Behavioral Finance

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What Is Common Among Return Anomalies?

Evidence from Insider Trading

Levon Goukasian, Qingzhong Ma & Wei Zhang

To cite this article: Levon Goukasian, Qingzhong Ma & Wei Zhang (2016) What Is Common
Among Return Anomalies? Evidence from Insider Trading, Journal of Behavioral Finance, 17:3,
229-243, DOI: 10.1080/15427560.2016.1170683

To link to this article: http://dx.doi.org/10.1080/15427560.2016.1170683

Published online: 15 Aug 2016.

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JOURNAL OF BEHAVIORAL FINANCE
2016, VOL. 17, NO. 3, 229243
http://dx.doi.org/10.1080/15427560.2016.1170683

What Is Common Among Return Anomalies? Evidence from Insider Trading

Levon Goukasiana, Qingzhong Mab, and Wei Zhangb
a
Pepperdine University; bCalifornia State University, Chico

ABSTRACT KEYWORDS
For a broad set of anomalies, we establish a common pattern of underreaction to information Anomaly; Underreaction;
contained in preceding insider trading activity. Our main analysis focuses on the anomalies short Insider trading; Insider
legs, which generate persistent negative abnormal returns. For stocks in the short legs, future silence
returns are systematically related to the information signal contained in preceding insider trading
activity, indicating underreaction. For insider trading information, we consider the possibility of net
buying, net selling, and no trading (or silence). The underreaction effect is economically signicant,
with the most negative signal accounting for an average of 71% of short-leg returns. This
underreaction effect survives numerous robustness checks and remains important after accounting
for investor sentiment, information environment, and limits to arbitrage.

Introduction
Prior research has found that numerous predetermined
rm characteristics predict stock returns in the cross-sec-
tion. More protable rms experience higher average future
returns (Haugen and Baker [1996], Cohen, Gompers, and
Vuolteenaho [2002]). Firms that invest more, however, on
average earn lower returns (Faireld, Whisenant, and Yohn
[2003], Titman, Wei, and Xie [2004], Cooper, Gulen, and
Schill [2008]). Jegadeesh and Titman [1993] document that
past winner stocks experience higher returns over the inter-
mediate term and past loser stocks experience lower
returns.1 Sloan [1996] nds that stock returns are negatively
correlated with accruals. Consistent with the combined evi-
dence that stock repurchases predict higher future returns
(Ikenberry, Lakonishok, and Vermaelen [1995]) and that
stock issuance predicts lower future returns (Loughran and
Ritter [1995]), Daniel and Titman [2006], Pontiff and
Woodgate [2008], and McLean, Pontiff, and Watanabe
[2012] show that net stock issues and future returns are
negatively correlated. Because these return patterns are not
explained by either the Capital Asset Pricing Model
(CAPM) or a multifactor asset pricing model such as the
three-factor model of Fama and French [1993], they are
often referred to as anomalies.
Whether return anomalies share common features is of
central interest to nance scholars.2 Establishing similarities
among anomalies is seen as an important step toward
understanding the nature of anomalous returns. Fama and
French [2008] study ve anomalies together (net stock
issues, momentum, accruals, asset growth, and protability)
and nd that abnormal returns mostly exist in extreme
portfolios formed on anomaly variables. Chen, Novy-Marx,
and Zhang [2011] develop an alternative three-factor model
to explain the anomalies. Stambaugh, Yu, and Yuan [2012]
examine the relation between investor sentiment and
anomaly returns and nd that high level of investor senti-
ment is systematically related to a broad set of return
anomalies. They motivate their work by arguing for a con-
nection between investor sentiment levels and prevalence
of mispricing. McLean and Pontiff [2012] show that market
frictions such as limits to arbitrage play an important role
in anomalies.
In this paper, we contribute to this research agenda by
testing a particular hypothesis across a broad set of
anomalies. Specically, we hypothesize that the abnor-
mal returns in the extreme anomaly portfolios (especially
the short legs, which generate signicant negative
returns) are partly due to investor underreaction to
information contained in preceding insider trading activ-
ity.3 We bring in insider trading to the context of anoma-
lies as a potential source of private information that helps
explain future returns. Corporate insiders are in a unique
position between the rm and stock market because they
have favored access to private information of a rm, of
which they are allowed to trade shares, to the legally per-
missible extent (e.g., Rozeff and Zaman [1998], Cohen,

CONTACT Qingzhong Ma qma@csuchico.edu Assistant Professor of Finance, Department of Finance and Marketing, College of Business, 325 Tehama
Hall, California State University Chico, CA 95928.
Color versions of one or more of the gures in the article can be seen online at www.tandf.com/hbhf
2016 The Institute of Behavioral Finance
230 L. GOUKASIAN ET AL.
Malloy, and Pomorski [2012]). This special position
makes insider trading activity potentially a rich source of
private information. We hypothesize that return anoma-
lies, particularly the abnormal returns in the extreme
portfolios formed on anomaly variables, are partly attrib-
utable to investors underreacting to the information con-
tained in preceding insider trading activity. If investors
underreact to insider trading information, the subse-
quent returns of the anomaly portfolios are expected to
be systematically related to preceding insider trading
information.
Precisely how to characterize the information con-
tained in preceding insider trading activity deserves a
careful discussion. Conventional wisdom suggests that
insider net buying (selling) would proxy for positive
(negative) information. That is, if insiders possess posi-
tive (negative) information they choose to buy (sell)
shares. When the regulatory and litigation risk associated
with insider trading is taken into account, however, this
view is incomplete. In this paper we consider insiders
decision to keep silent. That is, insiders choose not to
trade (neither buy nor sell) when expecting high liti-
gation risk.4 This concern for litigation risk is asymmet-
ric between buying and selling and is particularly strong
for insider sales.5 Thus, when the private information is
negative and insiders anticipate possible large price
drops, they do not sell. This is because shareholders
launch securities class-action lawsuits following large
stock price declines on the basis of Rule 10b-5, mostly
alleging that corporate insiders had foreknowledge about
the information that led to the price decline but failed to
promptly disclose it to the market.6 In such cases,
insiders selling activity would be taken as evidence that
insiders had the foreknowledge about the adverse infor-
mation.7 Therefore, ex ante, the best course of action for
insiders is not to sell, as lack of insider selling undercuts
plaintiffs allegation that insiders knew the information.8
Neither would they buy, given the negative prospects. As
a result, the high litigation risk associated with selling on
negative information induces rational insiders not to
trade at all. Therefore, insider silence (no insider trading
activity) is a proxy for negative private information, and
the existence of insider trading (either net buying or net
selling) is a proxy for relatively positive information.
Pulling together the above discussion regarding
insider silence and the conventional wisdom regarding
insider net buying and net selling, we characterize the
information contained in preceding insider trading activ-
ity in the following order from more negative to more
positive: insider silence, net selling, and net buying. Note
that preceding insider trading activity is publicly avail-
able information (see data section for details). In the con-
text of return anomalies, which are the papers focus, we
test the extent to which the abnormal returns associated
with the return anomalies are attributable to investors
underreacting to the information contained in preceding
insider trading activity. The underreaction hypothesis
predicts that future returns are lowest following insider
silence, and highest following insider net buying.
We study the ve anomalies examined in Fama and
French [2008]: net stock issues, momentum, accruals,
asset growth, and protability. Although our sample cov-
ers a relatively shorter time period (January 1990 to
December 2013) during which the insider trading data
are available, we conrm rst that the anomalies exist in
our sample period and are largely driven by the short
legs, in which stocks experience negative abnormal
returns. Our further analysis focuses on stocks in the
short legs.
Among rms in the short legs, we form portfolios
based on the information contained in their insider trad-
ing activity over the past six months.9 Firms whose
insiders keep silent, net buy, and net sell form the
silence, buy, and sell portfolios, respectively. For
these portfolios we examine their future returns, and
nd strong evidence of investor underreaction to the
information contained in insider trading activity. For the
month following portfolio formation, the silence port-
folio experiences signicant negative abnormal returns,
which are even lower than the sell portfolio, which in
turn underperforms the buy portfolio. These results
are consistent with the hypothesis that return anomalies
are partly due to investors underreacting to public infor-
mation contained in preceding insider trading activity.
Further, the impact of underreaction on the magnitude
of the anomalies short leg returns is economically signif-
icant. A back-of-envelope calculation suggests that
insider silence, the most negative information signal con-
tained in preceding insider trading activity, accounts for
an average of 71% of the abnormal returns in the short
legs. Overall, we identify a common pattern among a
broad set of anomalies: investors underreact to informa-
tion contained in insider trading activity.
The main results survive a battery of robustness
checks. They are robust to alternative methodologies of
measuring abnormal returns (returns adjusted by size
and book-to-market ratio vs. monthly regression alphas).
In addition, the underreaction effect remains after
accounting for the impact of investor sentiment, infor-
mation environment, and limits to arbitrage.
Although there are no signicant abnormal returns in
the long legs in our sample, which is short and more
recent (19902013), for completeness we also examine
the long legs and nd evidence of investor underreaction
to the information contained in insider trading activity.
In particular, signicant spreads exist between portfolios

formed on the most negative information signal (insider
silence) and the most positive information signal (insider
net buy).
Our paper contributes to understanding return anom-
alies by identifying a common pattern of investor under-
reaction to insider trading information. The evidence
suggests that investors underreact to public information
contained in insider trading activity and that a signicant
portion of the short-leg abnormal returns is character-
ized with insider silence, the most negative information
signal contained in preceding insider trading activity.
Our paper is also related to the literature on
insider trading and stock returns (e.g., Seyhun,
[1986], Rozeff and Zaman [1988], Lakonishok and
Lee [2001], Sias and Whidbee [2010], Cohen, Malloy,
and Pomorski [2012]). We examine the connection
between the public information extracted from insider
trading activity to future returns in the context of
return anomalies. The innovation is that we also con-
sider insiders decision not to trade. In this sense, our
paper is related to Gao and Ma [2012], who study
the phenomenon of insider silence among heavily
shorted stocks (short interest in the top quintile).
They nd that among these heavily-shorted stocks
insider silence predicts signicant negative abnormal
returns, which are even lower than when insiders net
sell. The two papers are complementary since both
show that insider silence is a negative information
signal. Our paper makes unique contribution by
applying the phenomenon of insider silence in the
context of return anomalies, about which Gao and
Ma [2012] keep silent. It is worth noting, however,
that this insider silence phenomenon is not our focus.
Our focus is the anomalies, which we believe are
important as they are related to market efciency. We
include insider silence in our analysis of anomalies
because it is an important piece of information con-
tained in insider trading activity. As such, in this
paper we do not pursue a full-edged examination of
insider silence. In addition, although litigation risk is
the perspective from which we motivate insider
silence, we are open to debate over alternative theo-
ries that relate insider silence to negative future
returns. Regardless, the strong evidence in our paper
along with extensive robustness checks suggests that
it is less debatable that insider silence is a negative
information signal.
The balance of the paper is organized as follows. In
the second section we describe the sample and data. The
third section presents the main results, followed by
extensive robustness checks in the fourth section. We
discuss the results on the long legs of the anomalies in
the fth section and conclude in the sixth section.
JOURNAL OF BEHAVIORAL FINANCE 231
Data and sample
We obtain insider trading data from Thomson Reuters
Insider Filing Data Feed. The Securities and Exchange
Commission (SEC) mandates that ofcers and directors,
large shareholders (those who own 10% or more of the
outstanding shares), and afliated shareholders report
their transactions to the SEC by the 10th of the month
following the transactions (prior to August 2002) or
within 2 days (since August 2002). Following previous
studies (e.g., Rozeff and Zaman [1998], Piotroski and
Roulstone [2005], Sias and Whidbee [2010]), we limit
our analysis to ofcers and directors because previous
research shows the information content of insider trad-
ing is mainly limited to trades by directors and ofcers.10
Dened in Equation 1, the net insider trading (NIT)
for month j is the total number of shares insiders buy
minus the total number of shares insiders sell over the
past 6 months, normalized by the total number of shares
outstanding at the end of month j-1. Our main analyses
are based on NIT measured over the past 6 months,
although our results are robust to NIT measured over
the past 3 or 12 months. Note that we use the insider
report date to calculate NIT. Thus, the insider trading
activity is publicly available information by the end of
month j-1.
#shares insiders buyj 6;j 1 #shares insiders sellj 6;j 1
NITj D
#shares outstandingj 1
(1)
To test whether anomalies are partly due to investors
underreacting to information contained in insider trad-
ing, we form portfolios based on the past insider trading
activities. Firms whose insiders do not trade over the
past six months form the silence portfolio; rms with
positive and nonpositive NIT form the buy and sell
portfolios, respectively. Future returns start from month
j.
We obtain stock return data from CRSP and account-
ing data from Compustat. We focus on the ve anoma-
lies examined in Fama and French [2008], whose
methodology we follow to construct the anomaly varia-
bles and estimate abnormal returns. The ve anomalies
are net stock issues, momentum, accruals, growth of
assets, and protability. All variables are dened in
greater detail in the Appendix.
The sample is based on all NYSE/Amex/NASDAQ
common stocks (share code 10 or 11) covered in CRSP/
Compustat merged database from January 1990 to
December 2013, a total of 288 monthly cross-sections.
The starting point of the sample period is determined by
when insider trading data are available. We apply
232 L. GOUKASIAN ET AL.
Figure 1. Insider Silence, Net Buying and Net Selling.
standard lters, excluding stocks whose prior month-end
price is lower than $2 and rms that are younger than a
year (from the rst month on CRSP le with valid price
and return data), and excluding nancial rms (Standard
Industry Codes between 6000 and 6999) and rms with
missing or nonpositive book value of equity. Because we
examine the 5 anomalies separately, we do not require
that all anomaly variables are nonmissing. Thus the aver-
age number of rms for a year/month varies across the
anomalies and is 3,274, 3,274, 2,963, 3,054, and 3,272 for
the anomalies of net stock issues, momentum, accruals,
growth of assets, and protability, respectively.
Figure 1 presents the proportion of rms with insider
net selling, net buying, and silence over the trailing 6-
month period. The data are monthly for the period from
January 1990 to December 2013. The proportion of
insider silence is over 40% in the early time and generally
declines over time. The sample average of insider silence
is 34%. Insider net selling is more frequent than net buy-
ing. This pattern is consistent with prior studies that
cover a similar time period (e.g., Sias and Whidbee
[2010], p. 1551).
Main results
Our portfolio construction closely follows Fama and
French [2008]. Specically, every month we rst sort
stocks into microcap and all but microcap (ABM, there-
after) groups, using the 20th NYSE size percentile as the
cutoff point. Within each size group we further form
portfolios based on 1 of the 5 anomaly variables. All
breakpoints come from the ABM rms only. For
momentum we form simple quintiles. For net stock
issues, we form quintiles for the positives (net issues), 2
equal groups for the negatives (net repurchases), and a
group for the zeros, resulting in a total of 8 groups. For
the other 3 anomalies (accruals, growth of assets, and
protability) we form 7 groups: 2 for the negatives and 5
for the positives. This is the same portfolio construction
method as in Fama and French [2008]. The portfolios
are rebalanced monthly and the holding period is
1 month.
The anomalous returns
Because our dataset covers a shorter and more recent
time period than most of the related prior studies, we
rst conrm that anomalous returns exist in the tails of
the anomaly variables in our sample. Specically, in
Table 1 we show the average abnormal returns of the
equal-weight portfolios sorted on each of the anomaly
variables over the 1-month holding period. For ease of
exposition the portfolios are ordered from the short legs
to the long legs, followed by the hedge (long minus
short) portfolios. For example, the top quintile of posi-
tive net stock issues (rms that issue equity heavily) pre-
dicts negative returns so it is the short leg and thus is
presented in the column to the left, and the lower half of
the negative net stock issues (rms that repurchase a
large amount) predicts positive returns so it is the long
leg and thus is presented in the column to the right. To
see the impact of rm size on anomaly returns we con-
duct the analysis for the whole market, microcap rms,
and ABM rms, respectively.
Panel A shows that the short leg of the net stock issues
anomaly produces a 1-month equal-weight abnormal
return of 0.52%, signicant at the 1% level. This pat-
tern holds for both microcap and ABM groups. This
 JOURNAL OF BEHAVIORAL FINANCE 233

Table 1. Average abnormal returns for portfolios formed using sorts on anomaly variables.
Panel A: Sort on Net Stock Issues (NS)

Positive Negative

Hi 4 3 2 Low Zero Hi Low Hedge

Market 0.52a 0.03 0.22a 0.19a 0.14c 0.43a 0.12 0.19b 0.70a
Micro 0.64a 0.07 0.27a 0.15c 0.18b 0.54a 0.15 0.19 0.83a
ABM 0.37a 0.02 0.16c 0.22a 0.09 0.16 0.11 0.19b 0.56a
Panel B: Sort on Momentum (MOM)

Loser 2 3 4 Winner Hedge

Market 0.46b 0.07 0.01 0.23a 0.56a 1.02a
Micro 0.66a 0.12 0.03 0.45a 0.74a 1.40a
ABM 0.19 0.02 0.00 0.06 0.33b 0.52
Panel C: Sort on Accruals (Ac/B)

Positive Negative

Hi 4 3 2 Low Hi Low Hedge

Market 0.17c 0.04 0.15b 0.11 0.04 0.02 0.09 0.26a

Micro 0.27b 0.04 0.15 0.15 0.11 0.04 0.06 0.33a
ABM 0.01 0.04 0.13c 0.07 0.00 0.01 0.12 0.12
Panel D: Sort on Asset Growth (dA/A)

Positive Negative

Hi 4 3 2 Low Hi Low Hedge

Market 0.45a 0.04 0.12 0.09 0.12c 0.18b 0.06 0.50a

Micro 0.63a 0.04 0.08 0.06 0.12 0.21b 0.06 0.69a
ABM 0.26c 0.10 0.15b 0.12c 0.13b 0.14c 0.02 0.29b
Panel E: Sort on Protability (Y/B)

Negative Positive

Low Hi Low 2 3 4 Hi Hedge

Market 0.29c 0.11 0.01 0.05 0.08 0.07 0.19 0.48b

Micro 0.28c 0.10 0.00 0.10 0.04 0.03 0.14 0.42c
ABM 0.24 0.12 0.01 0.03 0.11 0.12 0.21b 0.44c

The sample covers NYSE/Amex/NASDAQ common stocks from January 1990 to December 2013. We sort stocks on each anomaly variable and order the portfolios
from the short legs in the left to the long legs in the right, followed by a hedge portfolio (long minus short). For each portfolio we present the time-series aver-
age of the equal-weight abnormal returns over the month following portfolio formation. The rows Market, Micro, and ABM represent rms in the whole
market, microcap rms, and all-but-microcap rms, respectively. Microcap and ABM rms are separated by the 20th NYSE size percentile. For momentum we
form 5 quintiles; for protability, growth of assets, and accruals we form 5 quintiles for the positives and 2 equal groups for the negatives; for net stock issues
we form 5 quintiles for the positives, 2 equal groups for the negatives, and a group for the zeros. The breakpoints are based on ABM stocks only. The 5 anomaly
variables and abnormal return are dened in the Appendix. Superscripts a, b, and c refer to statistical signicance at the 1%, 5%, and 10% levels, respectively.

result is consistent with the literature that rms earn sig-
nicant negative returns after stock issuance. Consistent
with Fama and French [2008], stocks with zero net stock
issues are associated with signicant negative returns.
The returns associated with the other portfolios are rela-
tively less pronounced. All 3 hedge portfolios earn signif-
icant abnormal returns. The overall pattern is consistent
with Fama and French [2008] in that much of the action
in anomalous returns occurs in the extremes where the
anomaly variablein this case, net stock issuestakes
extreme values. What is noteworthy, there are no signi-
cant positive returns in the long legs, which is consistent
with investors exploiting academic research (McLean
and Pontiff [2012]). Due to limits to arbitrage, however,
the short legs, especially among microcap rms remain
signicant. This pattern of anomalous returns holds in
the other 4 anomalies as well, as shown in Panels B
through E of Table 1. The short legs experience signi-
cant negative returns, especially among microcap stocks.
Except for momentum, there is no strong evidence of
signicant positive abnormal returns in the long legs.
The result of no positive abnormal returns in the long
legs is expected because it is much easier for investors to
buy stocks on positive signals than to sell stocks short on
negative signals. Thus, it is relatively easy to arbitrage
away positive abnormal returns.
The overall ndings are consistent with Fama and
French [2008] in that most anomalous returns occur in
the extremes (short and/or long legs) and with McLean
and Pontiff [2012] in that investors exploit return
234 L. GOUKASIAN ET AL.

anomalies discovered by academic research subject to
costly arbitrage. The signicant returns in the short legs
prompt us to examine these portfolios rst.
Underreaction to insider trading information in the
short legs
We now test whether the abnormal returns in the
short legs are attributable to investors underreacting
to information contained in preceding insider trading
activity. To do so, for stocks within the short legs we
further form portfolios based on their insider trading
activities over the past 6 months. Firms without any
insider trading activity form the silence portfolio,
and rms with positive and nonpositive net insider
trading (NIT) form the buy and sell portfolios,
respectively. We then examine the portfolios abnor-
mal returns over the subsequent month. The underre-
action hypothesis maintains that information on
insider trading activity is not fully incorporated into
prices and predicts the following return pattern.
sell and silence portfolios, and between the buy
and silence portfolios.
Table 2 shows strong evidence of underreaction. In
the case of net stock issues, for example, the silence
portfolio experiences an average abnormal return of
0.94% over the subsequent month, while the returns of
the sell and buy portfolios are 0.37% and 0.07%,
respectively. Further, tests on the spreads clearly suggest
that the buy portfolio outperforms the sell portfolio,
which in turn outperforms the silence portfolio. This
pattern emerges in the other 4 anomalies as well. Except
for the buy-sell spreads of the net stock issues and asset
growth (dA/A) anomalies, all other spreads are highly
signicant.
To assess the economic signicance of investors
underreaction to the most negative information signal,
insider silence, we use Equation 2 to calculate, for stocks
in the short legs of the anomalies, the proportion of the
returns that is attributable to insider silence.
Proportion by insider silence

Rbuy > Rsell > Rsilence BHARexcluding thesilenceportfolio

D1 (2)
BHAR of all firms
Table 2 presents the portfolio abnormal returns for
each of the 5 anomalies, as indicated in the column head- For the anomaly of net stock issues, for example, the
ing. To test the hypothesis we present the spreads average abnormal return for all stocks in the short leg is
between the buy and sell portfolios, between the 0.517% (see Panel A of Table 1). Unreported for brev-
ity, the estimated average abnormal return excluding the
Table 2. Short legs by insider trading patterns. silence portfolio is 0.283%, which is a combination
Portfolios NS MOM Ac/B dA/A Y/B of the buy and sell portfolios. Equation 2 implies that
insider silence accounts for 45% (1.283/.517) of the
Buy 0.07 0.10 0.43a 0.08 0.50a
Sell 0.37a 0.39 0.16 0.33b 0.20
overall returns in the short leg. Following the same pro-
Silence 0.94a 0.90a 0.49a 0.85a 0.71a cedure, we nd this proportion is 64%, 100%, 45%, and
Buy - Sell 0.30c 0.49a 0.60a 0.25 0.70a 100% for the anomalies of momentum, accruals, growth
[1.88] [4.23] [4.10] [1.58] [4.39]
Sell - Silence 0.57a 0.51a 0.33b 0.52a 0.51a of assets, and protability, respectively.11 On average,
[3.92] [4.33] [2.46] [3.76] [3.35] insider silence accounts for 71% of the short leg returns
Buy - Silence 0.87a 0.99a 0.93a 0.77a 1.21a
[5.85] [9.15] [6.41] [4.91] [7.92] across the 5 anomalies.
In sum, Table 2 establishes a common pattern of
The sample covers NYSE/Amex/NASDAQ common stocks from January 1990
to December 2013. We sort stocks on each anomaly variable. For momen- investor underreaction to insider trading information
tum (MOM) we form 5 quintiles; for protability (Y/B), growth of assets (dA/ among stocks in the short legs of the 5 anomalies.
A), and accruals (Ac/B) we form 5 quintiles for the positives and 2 equal
groups for the negatives; for net stock issues (NS) we form 5 quintiles for First, stocks associated with more negative informa-
the positives, 2 equal groups for the negatives, and a group for the zeros. tion contained in insider trading activity earn signi-
The breakpoints are based on ABM stocks, with market capitalization above cantly more negative future returns. This result
the 20th NYSE size percentiles. We retain the short legs only. For stocks
within the short legs we further form portfolios based on their insider trad- supports the underreaction hypothesis that the signi-
ing activities over the past 6 months. Firms without any insider trading cant negative abnormal returns in the short legs of
activity form the silence portfolio, and rms with positive and nonpositive
net insider trading (NIT, dened in Equation 1) form the buy and sell the anomalies are partly due to investors underreact-
portfolios, respectively. For each portfolio we present the time-series aver- ing to information contained in preceding insider
age of the equal-weight abnormal returns over the month following portfo-
lio formation. The rows BuySell, SellSilence, and BuySilence trading activity. Second, insider silence, the most neg-
represent the return spreads between the corresponding portfolios. The t- ative information signal contained in insider trading
statistics are shown in brackets. The 5 anomaly variables and abnormal
return are dened in the Appendix. Superscripts a, b, and c represent statis- activity, accounts for an economically signicant por-
tical signicance at the 1%, 5%, and 10% levels, respectively. tion of the anomalous returns.
 JOURNAL OF BEHAVIORAL FINANCE 235

Table 3. Fama-french 3-factor alphas. rounded view we present both. For brevity we only
Portfolios NS MOM Ac/B dA/A Y/B present the buy-silence spreads in addition to the
individual portfolios. On an equal-weight basis, the
Panel A: Equal-weighted
Buy 0.39b 0.23 0.30c 0.28 0.19 buy-silence spread for the NS anomaly is 0.76%, simi-
Sell 0.60a 0.73a 0.33a 0.52a 0.57a lar in magnitude to the corresponding number
Silence 1.15a 1.14a 0.61a 1.03a 0.96a
Buy - Silence 0.76a 0.91a 0.91a 0.75a 1.16a reported in Table 2. On a value-weight basis, how-
[5.09] [8.40] [5.97] [4.79] [7.60] ever, the spread is only 0.11% (t D 0.39), much
Panel B: Value-weighted
weaker both statistically and economically. This pat-
Buy 0.35 0.18 0.20 0.37 0.10 tern of very strong results based on equal-weighting
Sell 0.31b 0.49c 0.32b 0.06 0.36 and relatively weaker results based on value-weighting
Silence 0.46b 0.66b 0.17 0.61a 0.36
Buy - Silence 0.11 0.48b 0.37 0.24 0.45 appears to hold in all the 5 anomalies. Thus, our
[0.39] [2.07] [1.44] [0.86] [1.29] results presented in Table 2 are robust to the Fama
The sample covers NYSE/Amex/NASDAQ common stocks from January 1990 and French [1993] regression approach. In addition,
to December 2013. We sort stocks on each anomaly variable. For momen- our results are stronger among smaller stocks.12
tum (MOM) we form 5 quintiles; for protability (Y/B), growth of assets (dA/
A), and accruals (Ac/B) we form 5 quintiles for the positives and 2 equal
groups for the negatives; for net stock issues (NS) we form 5 quintiles for
the positives, 2 equal groups for the negatives, and a group for the zeros. Subsamples formed on investor sentiment
The breakpoints are based on ABM stocks, with market capitalization above
the 20th NYSE size percentiles. We retain the short legs only. For stocks Stambaugh, Yu, and Yuan [2012] nd that for several
within the short legs we further form portfolios based on their insider trad- anomalies abnormal returns at least partially reect mis-
ing activities over the past 6 months. Firms without any insider trading
activity form the silence portfolio, and rms with positive and nonpositive pricing and are related to investor sentiment.13 They argue
net insider trading (NIT, dened in Equation 1) form the buy and sell that, during periods of high investor sentiment the most
portfolios, respectively. For each portfolio we rst calculate their equal-
weight abnormal returns over the month following portfolio formation. The optimistic views about many stocks tend to be overly opti-
time series portfolio returns are then regressed on the Fama and French mistic, and many stocks tend to be overpriced (p. 290).
[1993] 3-factor models. The table presents the intercepts from the regres-
sions. The row BuySilence represents the return spreads between the During low-sentiment periods, the most optimistic views
corresponding portfolios. The t-statistics are shown in brackets. The 5 about many stocks tend to be those of the rational invest-
anomaly variables and abnormal return are dened in the Appendix. Super-
scripts a, b, and c represent statistical signicance at the 1%, 5%, and 10%
ors, and thus mispricing during these periods is less
levels, respectively. likely. Thus, mispricing is more likely during high-senti-
ment periods than during low-sentiment periods.
Since investor sentiment has an important connection
Robustness checks with return anomalies, it is incumbent on us to test
whether the underreaction effect we nd holds after sen-
Alternative methodology: Monthly alphas
timent is accounted for. Most importantly, if investors
In our main analysis, we use the abnormal return underreaction to insider trading information is just a
adjusted by benchmark portfolios formed on size and manifestation of investor sentiment, the underreaction
book-to-market ratio. We check whether our results effect we identify would disappear after investor senti-
hold for alternative method of measuring abnormal ment is accounted for.
returns. To do so, we estimate monthly alphas from the To test whether underreaction to insider trading
Fama and French [1993] 3-factor model. Specically, fol- information survives after accounting for investor senti-
lowing the formation of each portfolio, we calculate the ment, we follow Stambaugh, Yu, and Yuan [2012] and
equal-weight and value-weight excess returns (net of the use the Baker and Wurgler [2007] investor sentiment
1-month Treasury bill returns) for all the portfolios, we monthly data to form 2 equal subsamples based on the
then regress the monthly excess returns on the Fama and time-series median. The rst subsample is the high senti-
French [1993] 3 factors and keep the intercepts as the ment subsample and the second subsample is the low
abnormal returns. sentiment subsample. Within each subsample we repeat
Table 3 presents the monthly alpha results on the our tests for underreaction among stocks in the short
equal-weight (Panel A) and value-weight (Panel B) legs of the 5 anomalies.
bases. Both equal-weight and value-weight structures Table 4 presents results for the 5 anomalies following
have pros and cons. Equal-weight gives the same periods of low (Panel A) and high (Panel B) sentiment.
weighting to each stock and is thus heavily inuenced The structure of the panels is similar to that of Table 2.
by the large number of stocks with very small market For brevity we only show the spread between the 2
capitalization. On the other hand, value-weight results extreme portfolios. For the NS anomaly, Panel A shows a
are heavily inuenced by a small number of stocks buy-silence spread of 0.64% (t D 2.99) during periods of
with very large market capitalization. To give a more low investor sentiment; Panel B shows a buy-silence
236 L. GOUKASIAN ET AL.

Table 4. Role of Investor Sentiment. information environment or stocks with stronger

Portfolios NS MOM Ac/B dA/A Y/B impediments to arbitrage.
We use institutional ownership and the number of
Panel A: Low sentiment
Buy 0.24 0.66b 0.83a 0.46c 1.02a analysts following as proxies for information environment.
Sell 0.10 0.11 0.09 0.04 0.31 Higher institutional ownership increases price discovery
Silence 0.40c 0.31 0.22 0.46b 0.14
Buy - Silence 0.64a 0.97a 1.04a 0.91a 1.17a and information efciency (Chiang, Qian, and Sherman
[2.99] [6.51] [4.88] [3.73] [5.24] [2010]); institutional investors take advantage of mispric-
Panel B: High sentiment
Buy 0.36 0.38 0.08 0.49 0.07
ing in equity markets (Cohen, Gompers, and Vuolteenaho
Sell 0.67a 0.89b 0.30c 0.72a 0.76b [2002], Campbell, Ramadorai, and Schwartz [2009]).
Silence 1.50a 1.51a 0.84a 1.35a 1.30a Thus, a higher level of institutional ownership implies
Buy - Silence 1.14a 1.14a 0.92a 0.86a 1.37a
[4.86] [6.53] [4.33] [3.88] [5.57] more intensive information acquisition, more informed
trading, and consequently more efcient prices (Sias,
The sample covers NYSE/Amex/NASDAQ common stocks from January 1990
to December 2013. Panel A (B) presents results for periods of low (high) Starks, and Titman [2006], Boehmer and Kelly [2009]).
investor sentiment. A month is dened as a period of low (high) investor Our second proxy is the number of analysts following the
sentiment if the prior month-end investor sentiment measure is below
(above) the time series median. We sort stocks on each anomaly variable. rm. Analysts collect, analyze and distribute information
For momentum (MOM) we form 5 quintiles; for protability (Y/B), growth of about a rm (Chen and Jiang [2006]). Thus a stock with
assets (dA/A), and accruals (Ac/B) we form 5 quintiles for the positives and 2
equal groups for the negatives; for net stock issues (NS) we form 5 quintiles
more analysts following is associated with better informa-
for the positives, 2 equal groups for the negatives, and a group for the tion environment and more efcient prices (e.g., Brennan
zeros. The breakpoints are based on ABM stocks, with market capitalization and Subrahmanyam [1995], Lang and Lundholm [1996],
above the 20th NYSE size percentiles. We retain the short legs only. For
stocks within the short legs we further form portfolios based on their insider Hong, Lim, and Stein [2000], Asquith, Mikhail, and Au
trading activities over the past six months. Firms without any insider trading [2005], Louis, Sun, and Urcan [2013]).
activity form the silence portfolio, and rms with positive and nonpositive
net insider trading (NIT, dened in Equation 1) form the buy and sell To explore the role of limits to arbitrage, we use stock
portfolios, respectively. For each portfolio we present the time-series aver- volatility as a proxy. According to Pontiff [1996, 2006]
age of the equal-weight abnormal returns over the month following portfo-
lio formation. The row BuySilence represents the return spreads between and Shleifer and Vishny [1997], real-life arbitrageurs face
the corresponding portfolios. The t-statistics are shown in brackets. The 5 costs and have relatively short investment horizons. Thus
anomaly variables and abnormal return are dened in the Appendix. Super-
scripts a, b, and c represent statistical signicance at the 1%, 5%, and 10%
arbitrageurs might be forced to liquidate their positions
levels, respectively. when the prices move against them. Stocks with greater
volatility exacerbate such risk. If arbitrageurs abstain from
spread of 1.14% (t D 4.86) during periods of high investor more volatile stocks, the prices are less efcient.
sentiment. Similarly, we nd signicant buy-silence Taken together, these arguments suggest that, among
spreads in both periods of low and high investor senti- rms in the anomaly short legs, those with lower institu-
ment and for all the 5 anomalies. Thus, these results sug- tional ownership, fewer analysts following, and higher
gest that the underreaction effect remains after accounting stock volatility are likely to exhibit a stronger underreac-
for investor sentiment. tion effect.15 We check whether the underreaction effect
remains after the information environment or limits to
arbitrage are accounted for.
Information environment and limits to arbitrage
In empirical analysis, we rst sort stocks indepen-
Zhang [2006] reports that information environment is dently on the anomaly variable, insider trading patterns,
important in understanding anomalies; McLean and and the proxy for information environment or limits to
Pontiff [2012] nd that costly arbitrage or limits to arbi- arbitrage. We then conduct the portfolio analysis for the
trage play an important role in the persistence of return subsamples formed on the proxy for information envi-
anomalies.14 We then check whether our underreaction ronment or limits to arbitrage. To maintain a reasonable
effect remains after accounting for information environ- number of stocks in each portfolio, we only form 2 sub-
ment and costly arbitrage. samples. Table 5 presents the results for subsamples
The evidence so far implies that either investors are formed on institutional ownership (Panels A-1 and A-2),
not fully rational about the insider trading information on number of analysts following (Panels B-1 and B-2),
or arbitrage is costly, or both. It is possible, for example, and on idiosyncratic volatility (Panels C-1 and C-2). For
that there are not enough investors who are informed the NS anomaly, the buy-silence spread is 1.02% (t D
about insider information, or that high stock volatility 5.56) for the subsample of stocks with institutional own-
acts as an impediment to arbitrage and prevents ership below the sample median and 0.58% (t D 2.75)
informed investors from fully exploiting the prot for the subsample of stocks with institutional ownership
opportunity. Therefore, the reported underreaction effect above the sample median. This pattern holds in the other
is expected to be stronger among rms with worse four anomalies as well. In addition, the buy-silence
 JOURNAL OF BEHAVIORAL FINANCE 237

Table 5. Role of Information Uncertainty or Limits to Arbitrage.

Panel A: Subsamples by Institutional Ownership.

Portfolios NS MOM Ac/B dA/A Y/B

Panel A-1: Low institutional ownership

Buy 0.18 0.02 0.56a 0.20 0.46b
Sell 0.67a 0.70a 0.33b 0.66a 0.37c
Silence 1.19a 1.15a 0.65a 1.11a 0.87a
Buy - Silence 1.02a 1.13a 1.21a 0.92a 1.33a
[5.56] [7.91] [6.54] [4.30] [7.59]
Panel A-2: High institutional ownership
Buy 0.11 0.20 0.26 0.18 0.53b
Sell 0.16 0.11 0.04 0.17 0.03
Silence 0.47b 0.49b 0.22 0.50b 0.23
Buy - Silence 0.58a 0.68a 0.48b 0.67a 0.76a
[2.75] [4.95] [2.15] [3.10] [2.67]

Panel B: Subsamples by Number of Analysts Following

Portfolios NS MOM Ac/B dA/A Y/B

Panel B-1: Few analysts following

Buy 0.18 0.14 0.32c 0.38c 0.40b
Sell 0.83a 0.73a 0.53a 0.80a 0.43b
Silence 1.25a 1.11a 0.71a 1.05a 0.89a
Buy - Silence 1.06a 0.96a 1.03a 0.67a 1.30a
[5.48] [7.25] [5.87] [3.11] [7.63]
Panel B-2: Many analysts following
Buy 0.11 0.27 0.54b 0.22 0.68b
Sell 0.16 0.20 0.10 0.17 0.10
Silence 0.37c 0.52b 0.05 0.59a 0.10
Buy - Silence 0.48b 0.79a 0.49b 0.81a 0.78a
[2.33] [5.35] [2.02] [4.02] [2.72]

Panel C: Subsamples by Idiosyncratic Volatility

Portfolios NS MOM Ac/B dA/A Y/B

Panel C-1: Low idiosyncratic volatility

Buy 0.21 0.37c 0.61a 0.31 0.51b
Sell 0.11 0.02 0.04 0.06 0.15
Silence 0.30c 0.14 0.23 0.28c 0.19
Buy - Silence 0.51a 0.52a 0.84a 0.59a 0.70a
[2.76] [3.61] [4.46] [2.83] [2.74]
Panel C-2: High idiosyncratic volatility
Buy 0.13 0.01 0.38b 0.15 0.46b
Sell 0.54a 0.59b 0.34b 0.55a 0.31
Silence 1.16a 1.16a 0.65a 1.14a 0.80a
Buy - Silence 1.03a 1.15a 1.03a 0.98a 1.27a
[5.29] [8.52] [5.32] [4.55] [7.26]

The sample covers NYSE/Amex/NASDAQ common stocks from January 1990 to December 2013. Stocks are independently sort on the anomaly variable (repre-
sented by the column heading), the prior insider trading pattern, and one of the proxies for information environment and/or limits to arbitrage (institutional
ownership in Panels A-1 and A-2; number of analysts following in Panels B-1 and B-2; and idiosyncratic volatility in Panels C-1 and C-2). These equal subsamples
are formed on the cross-sectional medians of the variables. For momentum (MOM) we form ve quintiles; for protability (Y/B), growth of assets (dA/A), and
accruals (Ac/B) we form 5 quintiles for the positives and 2 equal groups for the negatives; for net stock issues (NS) we form 5 quintiles for the positives, 2 equal
groups for the negatives, and a group for the zeros. The breakpoints are based on ABM stocks, with market capitalization above the 20th NYSE size percentiles.
We retain the short legs only. For stocks within the short legs we further form portfolios based on their insider trading activities over the past six months. Firms
without any insider trading activity form the silence portfolio, and rms with positive and nonpositive net insider trading (NIT, dened in Equation 1) form the
buy and sell portfolios, respectively. For each portfolio we present the time-series average of the equal-weight abnormal returns over the month following
portfolio formation. The BuySilence rows represent the return spreads between the corresponding portfolios. The t-statistics are shown in brackets. The ve
anomaly variables, abnormal return, institutional ownership, number of analysts following, and idiosyncratic volatility are dened in the Appendix. Superscripts
a, b, and c represent statistical signicance at the 1%, 5%, and 10% levels, respectively.

spreads are larger in magnitude for the subsample of
stocks with lower institutional ownership than those
with higher institutional ownership.
In Panels B-1 and B-2, the subsamples are formed on
number of analysts following. For the NS anomaly, the
buy-silence spread is 1.06% (t D 5.48) for stocks followed
by few analysts and 0.48% (t D 2.33) for stocks followed
by many analysts. The pattern also holds for the other
four anomalies, with one exception. In the anomaly of
asset growth (dA/A), the buy-silence spread is 0.67%
238 L. GOUKASIAN ET AL.

(t D 3.11) for stocks with few analysts following and Table 6. Fm regressions.
0.81% (t D 4.02) for stocks with many analysts following. Variables NS Mom Ac/B dA/A Y/B
The overall picture, however, shows a relationship
Buy 0.54a 0.50a 0.91a 0.67a 0.77a
between a wider buy-silence spread and the subsample [3.68] [4.43] [6.72] [4.66] [5.10]
of stocks followed by fewer analysts. Silence 0.34a 0.31a 0.06 0.25b 0.30b
[2.66] [2.93] [0.52] [2.06] [2.13]
Results in Panels C-1 and C-2 are also similar. For the MC 0.07c 0.08 0.08c 0.02 0.07
NS anomaly, for example, the buy-silence spread is [1.68] [1.32] [1.80] [0.38] [1.04]
B/M 0.12 0.09 0.01 0.02 0.09
0.51% (t D 2.76) for stocks with low idiosyncratic volatil- [1.48] [1.09] [0.08] [0.28] [0.95]
ity and 1.03% (t D 5.29) for stocks with high idiosyn- NS 1.60a 2.08a 1.86a 1.65a 2.26a
cratic volatility. Thus, the spreads are stronger in both [4.77] [5.13] [3.86] [4.35] [5.12]
Mom 0.56b 0.03 0.70a 0.65b 0.76a
subsamples and stronger when the idiosyncratic volatil- [2.44] [0.02] [3.30] [2.32] [4.28]
ity is higher. Such a pattern holds in all ve anomalies. Ac/B 0.24 0.00 0.20 0.46c 0.19
[1.05] [0.00] [0.57] [1.81] [0.96]
Table 5 shows that the underreaction effect is impor- dA/A 0.35c 0.82a 0.45b 0.39 0.54a
tant regardless of the information environment and lim- [1.97] [4.19] [2.21] [1.50] [2.69]
Y/B 0.25c 0.65a 0.06 0.56a 0.10
its to arbitrage. In addition, the results are consistent [1.67] [3.71] [0.44] [3.20] [0.85]
with the conjecture that worse information environment Intercept 0.43 1.48c 0.72b 0.33 0.44
[1.38] [1.74] [2.47] [0.91] [1.15]
and greater limits to arbitrage are associated with a lower Buy - Silence 0.88a 0.81a 0.97a 0.92a 1.07a
degree of price efciency and stronger underreaction [6.09] [7.55] [6.94] [5.86] [6.87]
effect. At the same time, the underreaction effect exists The sample covers NYSE/Amex/NASDAQ common stocks from January 1990
even among rms with better information environment to December 2013. We sort stocks on each anomaly variable. For net stock
and weaker limits to arbitrage. Thus, the underreaction issues (NS) we form 5 quintiles for the positives, 2 equal groups for the neg-
atives, and a group for the zeros; for momentum (Mom) we form 5 quintiles;
effect remains to be a common thread among the anom- for accruals (Ac/B), growth of assets (dA/A), and protability (Y/B) we form 5
alies even after accounting for these factors. quintiles for the positives and 2 equal groups for the negatives. The break-
points are based on all-but-microcap (ABM, market capitalization above
NYSE 20th percentile) stocks. We retain the short legs only in regressions.
The column heads specify the anomaly variable, based on which the short-
Fama-MacBeth regression results leg sample is constructed. The dependent variable is the 1-month abnormal
return following portfolio formation. The variable Buy is equal to one if
So far our analysis has treated the 5 anomalies indepen- the net insider trading (NIT) over the past 6 months is positive, and zero
dently. We now address two additional issues. First, the otherwise; and Silence is equal to one if the insiders of the rm do not
have any insider trading activity over the past 6 months, and zero other-
information contained in insider trading activity might wise. All other variables are dened in the Appendix. Each column lists the
be correlated with the anomaly variable itself, based on time-series average of the cross-sectional regression coefcients with t-sta-
tistics in brackets. Superscripts a, b, and c represent statistical signicance at
which the short leg is formed. Therefore, in the tests of the 1%, 5%, and 10% levels, respectively.
the relationship between information in insider trading
and stock returns we need to account for this potential anomaly variables we focus on. Each column presents
correlation. Second, while our short-leg portfolios are the time-series average coefcients from cross-sectional
formed on individual anomaly variables, returns are regressions; the t-statistics in brackets are based on time-
related to all the anomaly variables. series standard errors of the regression coefcients.
We address these issues in Fama-MacBeth regres- Because all anomaly variables are included in the regres-
sions. Specically, for stocks in the short leg of each sion, the sample sizes are slightly smaller than used in
anomaly we regress the 1-month abnormal return portfolio analysis on individual anomalies.
(adjusted by size and book-to-market ratio) on a list of Our focus is the coefcients for the silence and
explanatory variables. The main variables of interest are buy variables. Table 6 shows that all ve coefcients on
the two dummy variables: buy and silence. The vari- the buy dummy variable are positive and signicant,
able buy is equal to 1 if insiders of the rm net buy indicating that investors underreact to the information
over the past 6 months, and the variable silence is contained in insiders buying and selling activities, con-
equal to 1 if insiders of the rm do not trade over the rming previously reported results. The silence coef-
past 6 months. Thus, the benchmark case is the sell cients for all 5 regressions are negative and 4 are
because in this case both the silence dummy and the signicant, indicating that investors underreact to infor-
buy dummy equal zero. The control variables in the mation contained in insider silence, the most negative
regression include market capitalization, book-to-market information signal, conrming previously reported
ratio, and the 5 anomaly variables. To minimize the results. Overall, the regression results reconrm and sup-
impact of potential outliers we winsorize all continuous port the ndings from portfolio sorts. The coefcients on
variables at the 1st and 99th percentiles. Results are pre- the control variables are largely consistent with the litera-
sented in Table 6. The column heads represent the ture. Notably, net stock issues (NS) has negative
 JOURNAL OF BEHAVIORAL FINANCE 239

Table 7. Long leg results. portfolios are formed on an anomaly variable, investors
Portfolios NS MOM Ac/B dA/A Y/B should trade on just a subset of the stocks: short the
silence stocks in the short leg and buy the buy stocks
Buy 0.44a 1.23a 0.46a 0.61a 0.42b
Sell 0.17c 0.46a 0.11 0.10 0.18c in the long leg. The analysis in previous sections shows
Silence 0.11 0.48a 0.15 0.25c 0.05 that this enhanced strategy earns greater returns than the
Buy - Sell 0.27c 0.77a 0.36a 0.51a 0.24
[1.84] [5.38] [2.87] [3.26] [1.51] simple anomaly strategy without taking advantage of the
Sell - Silence 0.06 0.02 0.26b 0.36a 0.13 insider trading information.
[0.55] [0.18] [2.46] [2.62] [1.12]
Buy - Silence 0.33b 0.75a 0.62a 0.87a 0.37b
To implement the enhanced strategy, investors face dif-
[2.25] [5.13] [4.72] [5.97] [2.34] ferent transaction costs than the simple anomaly strategy.
The sample covers NYSE/Amex/NASDAQ common stocks from January 1990
To take transactions costs into account and to incorporate
to December 2013. We sort stocks on each anomaly variable. For momen- them into trading strategies, we use the Proportional Cost
tum (MOM) we form 5 quintiles; for protability (Y/B), growth of assets (dA/ Models and related ndings of Korajczyk and Sadka
A), and accruals (Ac/B) we form 5 quintiles for the positives and 2 equal
groups for the negatives; for net stock issues (NS) we form 5 quintiles for [2004]. They use two models, Effective and Quoted
the positives, 2 equal groups for the negatives, and a group for the zeros. Spreads, and estimate the impact of the transaction costs
The breakpoints are based on ABM stocks, with market capitalization above
the 20th NYSE size percentiles. We retain the long legs only. For stocks on the abnormal returns of investment strategies.16 When
within the short legs we further form portfolios based on their insider trad- effective spread is used as a measure of transactions costs,
ing activities over the past 6 months. Firms without any insider trading
activity form the silence portfolio, and rms with positive and nonpositive
the abnormal returns are reduced by 19 and 12 basis
net insider trading (NIT, dened in Equation 1) form the buy and sell points (bps) per month, for the equal-weight and value-
portfolios, respectively. For each portfolio we present the time-series aver- weight strategies, respectively. When quoted spread is
age of the equal-weight abnormal returns over the month following portfo-
lio formation. The rows BuySell, SellSilence, and BuySilence used to measure transactions costs the abnormal returns
represent the return spreads between the corresponding portfolios. The t- are reduced by 26 and 17 bps per month for the equal-
statistics are shown in brackets. The 5 anomaly variables and abnormal
return are dened in the Appendix. Superscripts a, b, and c represent statis- weight and value-weight strategies, respectively. Our
tical signicance at the 1%, 5%, and 10% levels, respectively. equal-weight strategy indicates that the trading strategy of
buying the buy stocks in the long legs and selling the
signicant coefcients in all 5 samples, and asset growth silence stocks in the short legs yields prots of 1.38%,
(dA/A) has negative coefcients. 2.13%, 0.95%, 1.46%, and 1.13% for the anomalies of NS,
MOM, Ac/B, dA/A, and Y/B, respectively.17 Apparently,
the trading costs of 19 or 26 bps reduce, but by no means
Underreaction in the long legs
eliminate the trading prots.
Our goal is to examine commonalities among the anom-
alous returns, which exist mainly in the short legs of the
Conclusion
anomalies. It is, nevertheless, curious whether the under-
reaction effect exists in the long legs as well. Return anomalies speak directly to the efcient market
Table 7 presents average abnormal returns for the hypothesis. Understanding what contributes to the
insider trading portfolios for stocks in the long legs. The anomalous returns is important. In this paper we add to
rst column shows results for the NS anomaly. The this line of research by testing a particular underreaction
buy portfolio earns an average return of 0.44%, which hypothesis, which posits that return anomalies are partly
is highly signicant. The silence portfolio is associated due to investor underreaction to information contained
with an insignicant return of 0.11%. The buy-sell spread in preceding insider trading activity. As an innovation,
is 0.27% (t D 1.84) and the buy-silence spread is 0.33% (t we consider the possibility of insider silence when we
D 2.25). The sell-silence spread is not signicant. Similar characterize the information contained in preceding
patterns hold for the other 4 anomalies. Notably, the insider trading activity. We argue that insider silence is a
spreads between the two extreme portfolios, buy-silence, negative information signal. Our analysis thus includes
are all positive and signicant. Overall, it appears that in the full spectrum of insider trading: buying, selling, and
the long legs there is evidence of investor underreaction silence.
to information contained in insider trading activity. For a broad set of anomalies, we establish a common
pattern of underreaction to information contained in the
preceding insider trading activity. Our main analysis
The role of transaction costs
focuses on the anomalies short legs, where persistent
Our analysis has practical implications. The results sug- abnormal returns exist. For stocks in the short legs, we
gest that investors take into account the information nd that future returns are systematically related to the
contained in prior insider trading activity when trading information signal contained in insider trading, support-
on the anomalies. Specically, after the short and long ing the underreaction hypothesis. We nd that the
240 L. GOUKASIAN ET AL.
underreaction effect is economically signicant, as the
most negative signal (insider silence) accounts for an
average of 71% of short-leg returns. This underreaction
effect survives numerous robustness checks and remains
important after accounting for investor sentiment, infor-
mational environment, and limits to arbitrage.
Acknowledgments
We thank an anonymous reviewer for the many insightful
comments and suggestions, which greatly improved the paper.
We are grateful to Farida Akhtar, Heitor Almeida, Hamza
Bahaji, Wally Boudry, Art Buser, Nicole Choi, Mohammed
Elgammal, Adam Farago, David Feldman, Valentina Galvani,
Ming Huang, Ravi Jagannathan, Meriem Jerbi, Michael John-
son, Andrew Karolyi, Karen Lewis, Claire Liang, Henock Louis,
Pam Moulton, David Ng, Akiko Watanabe, Eric Yeung, Kelvin
Chunhui Zhang, and seminar participants at the Cornell
nance brownbag, the 7th International Finance Conference in
Paris, France, the World Finance Conference at Cyprus, Multi-
national Finance Society 2013 conference at Izmir, Turkey, the
European Financial Management Association (EFMA) 2013
conference at Reading, United Kingdom, the 2013 European
FMA meeting at Luxembourg City, Luxembourg, and the 30th
International French Finance Association Conference at Lyon,
France for helpful discussions and suggestions, and Irene Kim
for advice on constructing the litigation risk data. We espe-
cially thank Andrey Ukhov for collaboration in earlier drafts.
This paper supersedes an earlier version previously circulated
as What is common among return anomalies? Evidence from
insider trading decisions. All errors are our own.
Notes
1. The literature on momentum is extremely large. See Jega-
deesh and Titman (2011) for a review. Recent work
includes Verardo [2009], Asem and Tian [2010], Stiver
and Sun [2010], and Antoniou, Doukas, and Subrahma-
nyam [2013].
2. In search of a common feature that can describe anoma-
lous returns, researchers have postulated that anomalous
returns are driven by mispricing (see, e.g., Daniel, Hirsh-
leifer, and Subrahmanyam [1998], Subrahmanyam [2007],
Antoniou, Doukas, and Subrahmanyam [2013], Stam-
baugh, Yu, and Yuan [2012]). An alternative view aims at
providing risk-based explanation for such return patterns
(Fama and French [2006, 2008], Chen, Novy-Marx, and
Zhang [2011]).
3. Investors tend to be less than completely rational. See, for
example, Chen and Lai [2013], Cohen and Kudryavtsev
[2012], and Nofsinger and Varma [2013].
4. Figure 1 shows this phenomenon is frequent.
5. See Bettis, Coles, and Lemmon [2000], Ke, Huddart, and
Petroni [2003], Cheng and Lo [2006, p. 821], Piotroski
and Roulstone [2008], Rogers [2008, p. 1269], and Lee,
Lemmon, Li, and Sequeira [2012], among others.
6. See OBrien and Hodges [1991], Francis, Philbrick, and
Schipper [1994], Skinner [1994], among others. For a
recent example of securities class-action lawsuits following
large stock price declines, see the case involving Yum!
Brands: http://securities.stanford.edu/1050/YUM00_01/
index.html.
7. See Grundfest and Perino [1997], Niehaus and Roth
[1999], Johnson, Nelson, and Pritchard [2007, p. 642],
Rogers [2008], Rogers, Van Burskirk, and Zechman
[2011, p. 2157], among others.
8. Niehaus and Roth [1999, p. 68] nd that insider selling
increases the probability of CEO turnover among rms
involved in shareholder class action lawsuits.
9. We use aggregate insider trading activity within rms,
although some insiders may be more informed than
others (e.g., Cohen, Malloy, and Pomorski [2012]).
10. We follow the literature (e.g., Lakonishok and Lee [2001];
Sias and Whidbee [2010]) to clean the insider trading
data. Specically, we use the following lters. We delete
duplicate and amended records and records with cleanse
code of S or A are deleted. Transaction price must be
available, and we delete records if the number of shares in
a transaction is below 100. The transaction code is either
P or S for stock transactions and M for options exer-
cised. We delete transactions that involve more than 20%
of total shares outstanding, and delete records if the trans-
action price is outside the 80120% range of the CRSP
end-of-day stock price.
11. We restrict this measure within the 0 and 1 range.
That is, if the proportion is greater than 100% it is set
to 100%; likewise, if this proportion is lower than 0%
it is set to 0%.
12. The main results hold in subsamples formed on mar-
ket capitalization. Using NYSE 20th size percentile as
the cutoff point to form two subsamples, we nd that
the BuySilence spreads are signicant for all anoma-
lies for both subsamples. The results are, as expected,
stronger among small cap stocks. In addition, the
main results hold when we vary the denitions of the
anomaly variables or when we use three- or 12-month
period to measure prior insider trading activity. Unre-
ported for brevity, these results are available upon
request from the authors.
13. Investor sentiment has been studied in many other con-
text. See, for example, Fong [2013], Fernandes, Goncalves,
and Vieira [2013] and Sturm [2014]. Investor sentiment is
part of the more general social mood, which has a broader
impact on nancial decision making (Nofsinger [2005]).
14. Other related work includes, for example, Ali, Hwang, and
Trombley [2003], Baker and Wurgler [2006], Brav, Hea-
ton, and Li [2010], Lam and Wei [2011], and Choi and
Sias [2012], among others.
15. In unreported analysis, we rst conrm that the abnormal
returns in the short legs of the ve anomalies are stronger
when information environment is worse (lower institu-
tional ownership, few analysts) or when the limits to arbi-
trage is more severe (higher idiosyncratic volatility).
16. Korajczyk and Sadka [2004] measure effective spreads as
the absolute price relative to midpoint of quoted bid and
ask, and quoted spreads as the ratio of quoted bid-ask
spread and the bid/ask midpoint.
17. These numbers are calculated by subtracting the silence
row in Table 2 from the buy row in Table 7. For exam-
ple, for the NS anomaly, the abnormal return of buying
the buy stocks in the long leg is 0.44% and that of selling

the silence stocks in the short leg is 0.94%, resulting in a
prot of 1.38%. This prot will remain signicant even
after subtracting the monthly trading costs of 26 bps.
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 JOURNAL OF BEHAVIORAL FINANCE 243

Appendix
The data sources are the Center for Research in security Prices (CRSP), Compustat, Thomson Reuters Insider Filing
Data Feed, I/B/E/S, and Thomson 13f institutional ownership database. Following Fama and French [2008] we mea-
sure the anomaly variables by June of year t to forecast the returns in July of t to June of tC1. The exception is momen-
tum, which is updated every month. Time t in Compustat refers to scal year end in calendar year t. The main
variables are dened below.

Firm Characteristics
MC: Market capitalization, the natural log of price times number of shares outstanding at the end of
June of year t, from CRSP.
B/M: Book-to-market ratio, the natural log of the ratio of the book value of equity to the market value
of equity. Book value B is total assets (Compustat item AT) for year t-1, minus liabilities (LT),
plus balance sheet deferred taxes and investment tax credit (TXDIC) if available, minus
preferred stock liquidating value (PSTKL) if available, or redemption value (PSTKRV) if
available, or carrying value (PSTK). Market value M is price times share outstanding at the end
of December of t-1, from CRSP.
Anomaly Variables
NS: Net stock issues, the natural log of the split-adjusted shares outstanding at the scal year end in
t-1 minus the natural log of the split-adjusted shares outstanding at the scal year end in t-2.
The split-adjusted shares outstanding is CSHO times AJEX in Compustat.
Mom: Momentum, the buy-and-hold return from month j-12 to j-2, where j-1 is the month of portfolio
formation and j is the rst month of forecasted stock returns. This variable is monthly
rebalanced.
Ac/B: Accruals, the change in operating working capital per share (split-adjusted) from scal year t-2 to
t-1, divided by book equity per share (split-adjusted) in year t-1. Operating working capital is
current assets (Compustat item ACT) minus cash and short-term investment (CHE) minus
current liabilities (LCT) plus debt in current liabilities (DLC).
dA/A: Growth in assets, the natural log of assets per share (split-adjusted) at the scal year end in t-1,
minus the natural log of assets per share (split-adjusted) at the scal year end in t-2.
Y/B: Protability, equity income (IB), minus dividends on preferred (DVP), if available, plus income
statement deferred taxes (TXDI), if available of scal year end in t-1, normalized by book
value of equity in scal year t-1.
Insider Trading Variable
NIT: Net insider trading, NIT of month j is dened as the number of shares that insiders buy minus
the number of shares that insiders sell over the past six months, normalized by the total
number of shares outstanding at the end of month j-1. For robustness we also vary the
measuring window from 1 month to 12 months.
Information Environment and Limits to Arbitrage Variables
IO: Institutional ownership, the percentage owned by institutional shareholders as of the most
recent quarter end.
Analysts: Number of analysts following the stock as of the most recent month end. Missing value is set to
zero.
Idiosyncratic Volatility: Idiosyncratic volatility estimated within the past 3 months. We regress daily returns of the stock
on the CRSP value-weighted market returns and calculate the standard deviation of the
residuals.
Return Variable
Abnormal returns: We construct abnormal return (BHAR) in a way similar to the recent literature. Specically, at the
end of June of year t, we independently form NYSE size and booktomarket (B/M) quintiles
to extract the breakpoint values, and assign AMEX and NASDAQ stocks to the 55 portfolios
according to their size and B/M values. The valueweight portfolio return serves as the
benchmark return for the stock in the same size and B/M portfolio for the months starting
from July of year t to June of year tC1. Portfolio assignment is rebalanced every year.
Abnormal return for stock j for a month t is dened as the raw return of stock j minus the
benchmark portfolio return. If a stock is delisted the delisting return is used for the month.