Informed Trading and the Cost of Capital

Does information asymmetry among traders of a firm’s stock increase its cost of capital? We first show that institutional traders in the Shanghai Stock Exchange have a strong information advantage. We then show that past aggressiveness of institutional trading in a stock is a good predictor of institutions’ current and future information advantage in this stock. Sorting stocks on this predictor and controlling for other known correlates of expected returns, we find that the top quintile’s average annualized return in the next month is 10.8% higher than the bottom quintile’s, indicating that information asymmetry raises the cost of capital. Email: [email protected], [email protected], [email protected]. We thank Alexander Ljunqvist, Roger Loh, Jialin Yu, and audience members at ABFER, Brigham Young University, Brown, Cheung Kong GSB, CICF, Hong Kong University, HKUST, INSEAD, NYU, SUNY Binghamton, University of Rochester, University of Toronto, and Yale for their insightful comments.