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A CMCRC study reveals that prior to the public release of stock recommenda- tions, associated institutions experience abnormal trading volume suggesting evidence of “tipping” to privileged clients. This effect is greatest for small and mid-cap stocks.
Ming Ying Lim CMCRC PhD candidate Macquarie U. A/Professor Andrew Lepone CMCRC Research Associate U. of Sydney Keywords: Capital markets, market quality
Analyst recommendations are generally perceived to be valuable as they provide either new information or disseminate existing content across a wider audience. Broking institutions invest heavily in collecting, analysing and publishing research and recommendations. Reliant upon clients’ trading volumes, brokerage firms pro- duce the reports to persuade clients to trade with them. A study conducted by Ming Ying Lim, Dr Jin Boon Wong and Professor Andrew Lepone examines broker trading volume before and after analyst recommenda- tions are made public. Results from the research shows spikes in trading volume (by recommending broker) before the public release of the analyst reports. This evidence suggests that prior to the public release, analyst recommendations are likely supplied to the broker’s client base (private release) to entice trading. In turn, brokers are financially compensated for their research endeavours via trading com- missions from their clients. Ying’s research crunches publically available data that contains brokers ID for ap- proximately 3,800 analyst recommendations on 338 ASX listed stocks from Novem- ber 2004 to November 2006. The results document that after the private release of the information, trading activity increases most significantly for small and medium- cap stocks. Since smaller stocks have less analyst coverage, it is likely that analyst recommendations in these stocks provide new information to the market which provides greater profit potential from “tipping” activities. It was also noted that a direct relationship exists between recommendation changes (from buy to sell or vice versa) and volume as significant changes in trading volume eventuated from recommendation changes. The research also examines the market impact costs of trades executed after the public release of recommendations using intraday trade-by-trade data. Evidence shows that price impact asymmetry exists with upgrade recommendations caus- ing larger price impact for buys and downgrade recommendations causing larger price impact for sells. Interestingly, once broker ID anonymity was introduced on the 28th November 2005, Ying’s research shows that this results in lower market impact costs for the recommending broker as the anonymity takes away the exploi- tation opportunity for the other brokers.
Ming Ying Lim, Andrew Lepone, Jin Boon Wong