Informed trading by hedge funds

Abstract

AbstractUsing daily equity transactions, we create a hedge fund informed trading measure (ITM) that separates concentrated information‐related trades from liquidity‐driven basket trades. We find that stocks with higher ITM are associated with higher future stock performance. The long–short portfolio delivers 4% annual alpha after controlling for size, value, momentum, and illiquidity factors. We attribute informed trading to hedge funds' ability to identify and correct stock underpricing. The results are robust to several ways of constructing and sorting the measure, and we do not find a return reversal in four quarters, indicating that the measure is information related.