FIN-01-009

Information Asymmetry about the Firm and the Permanent Price Impact of Trades: Is there a Connection?

October 2001

Gideon Saar and Lei Yu

ABSTRACT

Spread decomposition and variance decomposition methodologies have been developed and used in the literature to obtain measures of information asymmetry about firms. We examine the relation between these market microstructure measures and information asymmetry about the future cash flows of firms. First, to test whether differences in information asymmetry are sufficient to generate differences in the estimated measures, we examine a large cross-section of stocks employing various proxies for uncertainty about future cash flows or informativeness of prices. We find that the market microstructure measures do not consistently reflect uncertainty about future cash flows or relate to the informativeness of prices in a manner that is compatible with their use as proxies for information asymmetry. Second, to test whether changes in information asymmetry about the firm are necessary for the estimated measures to change, we conduct an event study of the Russell 1000 index reconstitution. We find that the information asymmetry measures change around the event despite the fact that Russell 1000 membership is based on market capitalization and therefore the event is not associated with any change in private information about the firms.

Classification: Market Microstructure/Empirical

Gideon Saar
Institution: Leonard N. Stern School of Business, New York University
Telephone: 212-998-0318
Fax: 212-995-4233
Email: gsaar@stern.nyu.edu
Home Page: http://www.stern.nyu.edu/~gsaar/

Lei Yu
Institution: Leonard N. Stern School of Business, New York University
Telephone: 212-998-0321
Fax: 212-995-4233
Email: lyu@stern.nyu.edu

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