Financial analysts play an intermediary role in financial markets, resulting in two steps for information to be fully absorbed into the stock price: analysts reaction to information, and investors reaction to analysts recommendations. Thus any observed inefficiency in stock pricing could result from two possibilities: analysts failed to fully incorporate the market information into their stock analysis, or the information released in the analysts report is not fully believed by investors. <p>The documented optimism of financial analysts may suggest the possibility of the later case. To test the accuracy of analysts from another perspective, we follow a market microstructure model and use intraday market data to estimate the probability of an information event, the probability of good or bad news, and the rates that different traders arrive at the market. <p>By comparing those estimates based on days with and without recommendation changes, we find inconsistent results with regard to a difference in the probability of an information event. For some stocks, we do observe an increase in the likelihood of news on days when analysts change their recommendations, but this is not the case for most stocks. However, even though they are inaccurate most of the time, uninformed investors usually believe financial analysts. Furthermore, it seems that uninformed investors disbelieve analyst recommendation changes at those instances when analysts are most accurate. <p> Because of this, we hypothesise that market makers might suspect that orders in the opposite direction of an analysts recommendation change are more likely to come from informed traders. This is consistent with the intuition that most traders are uninformed and will simply follow the advice of a perceived expert, and therefore those that dont follow that advice may be more likely to have special information of their own. We check whether there are any differences in the probability of information-based trading (PIN) and for the conditional probability of information-based trading conditioned on sell (PIN|sell) and buy (PIN|buy) between days with and without recommendation changes. We did not find any significant difference, indicating that although we may observe a higher arrival rate of informed traders on recommendation change days, the probabilities of information-based trading do not change substantially. More informed traders seem to come to the market merely because the higher arrival rate of uninformed traders on recommendation days gives them a good opportunity to camouflage their behaviour. And the specialists likely would not have to change their behaviour on those days by increasing or shifting bid-ask spreads since the increased costs from the higher volume of informed trading are balanced by increased profits from the higher volume of uninformed trading. <p>Furthermore, regression of the probabilities of informed trading (conditional or unconditional) on firm size, trading volume, and volatility of daily return shows nothing significant, so we werent able to identify influential factors that affect informed trading or explain differences in informed trading between firms.

Financial analysts play an intermediary role in financial markets, resulting in two steps for information to be fully absorbed into the stock price: analysts reaction to information, and investors reaction to analysts recommendations. Thus any observed inefficiency in stock pricing could result from two possibilities: analysts failed to fully incorporate the market information into their stock analysis, or the information released in the analysts report is not fully believed by investors. <p>The documented optimism of financial analysts may suggest the possibility of the later case. To test the accuracy of analysts from another perspective, we follow a market microstructure model and use intraday market data to estimate the probability of an information event, the probability of good or bad news, and the rates that different traders arrive at the market. <p>By comparing those estimates based on days with and without recommendation changes, we find inconsistent results with regard to a difference in the probability of an information event. For some stocks, we do observe an increase in the likelihood of news on days when analysts change their recommendations, but this is not the case for most stocks. However, even though they are inaccurate most of the time, uninformed investors usually believe financial analysts. Furthermore, it seems that uninformed investors disbelieve analyst recommendation changes at those instances when analysts are most accurate. <p> Because of this, we hypothesise that market makers might suspect that orders in the opposite direction of an analysts recommendation change are more likely to come from informed traders. This is consistent with the intuition that most traders are uninformed and will simply follow the advice of a perceived expert, and therefore those that dont follow that advice may be more likely to have special information of their own. We check whether there are any differences in the probability of information-based trading (PIN) and for the conditional probability of information-based trading conditioned on sell (PIN|sell) and buy (PIN|buy) between days with and without recommendation changes. We did not find any significant difference, indicating that although we may observe a higher arrival rate of informed traders on recommendation change days, the probabilities of information-based trading do not change substantially. More informed traders seem to come to the market merely because the higher arrival rate of uninformed traders on recommendation days gives them a good opportunity to camouflage their behaviour. And the specialists likely would not have to change their behaviour on those days by increasing or shifting bid-ask spreads since the increased costs from the higher volume of informed trading are balanced by increased profits from the higher volume of uninformed trading. <p>Furthermore, regression of the probabilities of informed trading (conditional or unconditional) on firm size, trading volume, and volatility of daily return shows nothing significant, so we werent able to identify influential factors that affect informed trading or explain differences in informed trading between firms.

As individuals or families hold a substantial share of a firm at the cost of less diversified portfolio, they specialize their portfolio and have better inside information. Does the market marker react to this fact and maintain higher level of asymmetric information cost for such family-controlled firms? We analyze the bid-ask spread and the probability of informed trading (PIN) of Canadian-based publicly traded firms cross-listed with NYSE/AMEX to test this notion. We find that although the market maker maintains higher average spread, he does not form higher PIN for family-controlled firms when the entire day is considered as an event period. <p>The assumption of constant arrival rates of informed and uninformed traders during the day in Easley et al (1996b) is rejected in the two periods per day analysis. In addition, the notion of information event occurrence prior to the day in Easley et al (1996b) is consistently rejected as higher (non-statistically) probability of information events is found in the afternoon (second session) in the two (three) periods per day analyses, respectively. Based on these findings, we have serious doubts about any existing findings (including ours) of PIN based on one period per day. As such, we consider the possibility of several periods per day.<p>Though it remains an empirical question to choose how many periods should be considered, we find our results using two and three periods per day to be very interesting. We consistently reject the hypothesis that the PIN is higher for family-controlled firms. Since the market maker does not need to maintain high spread for firms with very high number of uninformed traders and very low number of informed traders, we do not perceive our findings to be either surprising or contradictory to the present literature. By developing a different formulation of PIN, we also show that this is empirically less than that developed by Easley et al (1996b).

As individuals or families hold a substantial share of a firm at the cost of less diversified portfolio, they specialize their portfolio and have better inside information. Does the market marker react to this fact and maintain higher level of asymmetric information cost for such family-controlled firms? We analyze the bid-ask spread and the probability of informed trading (PIN) of Canadian-based publicly traded firms cross-listed with NYSE/AMEX to test this notion. We find that although the market maker maintains higher average spread, he does not form higher PIN for family-controlled firms when the entire day is considered as an event period. <p>The assumption of constant arrival rates of informed and uninformed traders during the day in Easley et al (1996b) is rejected in the two periods per day analysis. In addition, the notion of information event occurrence prior to the day in Easley et al (1996b) is consistently rejected as higher (non-statistically) probability of information events is found in the afternoon (second session) in the two (three) periods per day analyses, respectively. Based on these findings, we have serious doubts about any existing findings (including ours) of PIN based on one period per day. As such, we consider the possibility of several periods per day.<p>Though it remains an empirical question to choose how many periods should be considered, we find our results using two and three periods per day to be very interesting. We consistently reject the hypothesis that the PIN is higher for family-controlled firms. Since the market maker does not need to maintain high spread for firms with very high number of uninformed traders and very low number of informed traders, we do not perceive our findings to be either surprising or contradictory to the present literature. By developing a different formulation of PIN, we also show that this is empirically less than that developed by Easley et al (1996b).