HIRSCHEY

How Well Do Traders Condition on the Uniqueness of Their Signals? with Chishen Wei... This paper provides evidence that hedge funds and mutual funds neglect to properly condition on prices when trading on earnings announcements. This leads to predictable excess trading when many funds have similar signals, because they underestimate how much of their information is already incorporated into prices. Consistent with this excess trading causing temporary price impact, a portfolio long stocks that had excess selling and short stocks that had excess buying has an annualized Sharpe ratio near 1.0 after hedging exposure to common risk factors. Our findings are useful for understanding how asset prices are affected when a trader underestimates how many other investors follow similar investment strategies.

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