Are Accruals Profits Illusory to Informed Traders?∗

We find that accruals mispricing is more pronounced for stocks with higher level of probability of informed trading (PIN). We interpret it as the evidence of informed traders using their proprietary information on accruals quality to trade against average investors. The informed traders’ arbitrage generates an annualized size and book-to-market adjusted abnormal return of 19.81% over the 1993-2002 period. Using three different methods to estimate the transaction costs and the impact of various market frictions on the accruals strategy, we find that informed traders make an abnormal return of 6.5%–17.53% after trading costs. Our findings are robust to testing methods, asset pricing models used, and various ways of controlling for trading costs. They suggest that the persistence of accruals anomaly might be driven by the non-diversifiable information risk rather than higher trading costs of extreme accruals stocks. We also design a strategy for uninformed traders to mimick informed traders’ behavior, and find that it generates profits equivalent to those obtained by the informed traders. JEL Classification: G1, M4