Informed Trading and Expected Returns

Does information asymmetry affect the cross-section of expected stock returns? Using institutional ownership data from the Shanghai Stock Exchange, we show that institutions have a strong information advantage over individual investors. We then show that the aggressiveness of institutional trading in a stock--measured by the average absolute weekly change in institutional ownership during the past year--is an ex ante predictor of future information asymmetry in this stock. Sorting stocks on this information asymmetry predictor, we find that the top quintile outperforms the bottom quintile next month by 10.8% annualized, suggesting that information asymmetry raises the cost of capital.