Sophisticated Trading and Market Efficiency: Evidence from Macroeconomic News Announcements

This paper studies how the views of sophisticated traders are impounded into stocks and bonds around macroeconomic news announcements. I find evidence that sophisticated traders trade on predictions of macroeconomic news reports before announcements and obtain their informational advantage using public information. Specifically, consensus forecasts of upcoming data releases suffer from anchoring bias and overweight past data releases. By correcting this bias, sophisticated traders can predict news reports. The results suggest that stock and bond markets are inefficient in this setting. Over time, there is a “late trading puzzle”: sophisticated traders can predict news reports days before announcements but appear to trade these predictions into stock and bond prices just hours before announcements. Across assets, there is a related puzzle: the predictable component of news reports is eventually fully impounded into bonds but only partially impounded into stocks. Stocks but not bonds react to announcements of the predictable component and display return momentum. I develop a model showing that market inefficiency can arise when unsophisticated traders neglect public information that predicts news reports, and risk management concerns deter sophisticated traders from acting on their informational edge. Trading earlier and trading riskier assets such as stocks exposes sophisticated traders to greater risk. As a result, sophisticated traders wait to trade and trade safer assets such as bonds. ∗Harvard University. [email protected]. I am particularly grateful to John Campbell, Jeremy Stein, Robin Greenwood, and Owen Lamont. I also thank Lauren Cohen, Sam Hanson, Chris Malloy, Erik Stafford, Andrei Shleifer, Adi Sunderam, Luis Viceira, and seminar participants at Harvard for helpful discussions and suggestions. For the latest version, please visit http://scholar.harvard.edu/jzhou.