Information Shocks and the Cross-section of Expected Returns

This paper examines the risk premium associated with the information shocks in equity markets. For all stocks traded in Borsa Istanbul between March 2005 and December 2020, we calculate information shocks as the unanticipated information asymmetry by focusing on the changes in the proportion of the effective spread attributable to adverse selection. Our results indicate a significant return premium for the information shock strategy. Specifically, the return premium associated with the zero-investment information shock portfolios is 72 bps. We further document a significant predictive relationship between information shocks and future returns after controlling for several factors. The predictive power and the return premium associated with the information shock strategy are stronger after the BISTECH trading system, which enabled heterogeneity across investors vis-à-vis trade execution latency. These results suggest that risks associated with information shocks can become systematically important for the cost of equity after the introduction of fast trading