How does informed trading affect the information environment? Looking at the Chinese stock market from the perspective of the speed of information integration

• Author: Yingyi Hu
• DOI: http://doi.org/10.1111/infi.12134
• Date: 01 December 2018
• Published date: 01 December 2018

DOI: 10.1111/infi.12134

ORIGINAL ARTICLE

How does informed trading affect the information

environment? Looking at the Chinese stock market

from the perspective of the speed of information

integration

Yingyi Hu

Institute of Chinese Financial Studies,

Southwestern University of Finance and

Economics, Wenjiang District, Chengdu,

China

Correspondence

Yingyi Hu, Institute of Chinese Financial

Studies, Southwestern University of

Finance and Economics, 555 Liutai

Avenue, Wenjiang District, Chengdu

611130, China.

Email: huyingyi@icfs.swufe.edu.cn

Funding information

Humanity and Social Science Fund of the

Ministry of Education of China,

Grant number: 10YJC790087

Abstract

This paper investigates the informational environment of

the Chinese stock market from the perspective of the

integration speed for firm-specific information and market-

wide information. Our empirical evidence shows that, while

informed trading increases the integration speed for firm-

specific information as information asymmetry dissipates

over time, the trading costs related to information

asymmetry that results from informed trading on firm-

specific information negatively affect the integration speed

for market-wide information. This study provides evidence

on the interaction between different information sets and

could be generalized to, and has strong empirical

implications for, other emerging markets that have more

significant problems with information asymmetry.

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INTRODUCTION

In the existing literature, the information environment is examined in terms of the relationship between

different information sets. For example, price synchronicity (R

2

) (i.e. the proportion of variation in

securities prices that can be explained by movements in market returns), which is closely related to the

integration level of firm-specific information and market-wide information into prices, is generally

considered a measure of information environment and price informativeness; and the interaction of

different partial information sets is also theoretically analysed in the literature (Cullen, Gasbarro, &

Monroe, 2010; Han, Tang, & Yang, 2016). However, we still do not have a clear empirical picture of

the contribution of informed trading on firm-specific information to the information environment and

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© 2018 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/infi International Finance. 2018;21:316–332.

the mechanism of interaction between firm-specific information and market-wide information in

emerging markets. In particular, information asymmetry is generally thought to be more obvious in

emerging markets than in developed markets because their accountancy system is less transparent.

The speed of information integration is an important aspect of the information environment. In this

study, we first construct a new measure of firm-specific information integration speed and use a well-

established measure of market-wide information integration speed. We then relate these two measures

of information integration speed to the information asymmetry measured over different time horizons

by controlling for different variables, such as market capitalization, price volatility, and trading costs.

Our empirical results show that, while informed trading has a significantly positive effect on firm-

specific information integration speed as the information asymmetry dissipates over time, the trading

costs related to informed trading on firm-specific information lower the integration speed for firm-

specific information over short horizons. The processes of information integration for firm-specific

information and market-wide information are not independent. The trading cost that results from

informed trading on firm-specific information negatively affects the integration speed for market-wide

information.

We make the following contributions to the literature. First, traditional analyses of the information

environment concentrate on the comparative level of integration between firm-specific information

and market-wide information. Here, we provide another perspective on interactions between different

information sets by analysing the information integration speed for firm-specific information and

market-wide information. Second, the Chinese stock market is an emerging stock market with rapid

development that is dominated by individual traders, who contribute the majority of the trading volume

(Lee, Li, & Wang, 2010). It is also characterized by an accountancy system that is not very transparent

and poor-quality analyst reports (Firth, Lin, Liu, & Xuan, 2013; Gu, Li, & Yang, 2013). However, the

impact of trading costs related to informed trading in emerging markets, which are consequently

thought to be more important, remains unexplored empirically. We fill this gap by analysing the effect

of information asymmetry on information integration processes for firm-specific information and

market-wide information in the Chinese stock market.

The remainder of this paper is organized as follows. Section 2 provides a brief description of the

Chinese stock market. Section 3 presents the theoretical considerations. Section 4 describes the data

and methods of analysis. Section 5 outlines our empirical results, and section 6 gives our concluding

remarks.

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MARKET STRUCTURE IN CHINA

In China, stocks can be listed either on the Shanghai Stock Exchange (SHSE) or on the Shenzhen Stock

Exchange (SZSE) but not both. The SHSE operates the main board, which is the most important and

has the most stringent listing requirements. The SZSE runs not only the main board but also the Small

and Medium-Size Enterprise (SME) board, which was created in 2004, and the ChiNext board, which

was created in 2009 and aims to attract innovative and rapidly growing enterprises, particularly high-

tech firms. ChiNext is a NASDAQ-style board, and its listing standards are less stringent than those of

the main and SME boards.

Compared to the U.S. stock market, the Chinese stock market is characterized by the dominance of

individual investors (Lee et al., 2010), who engage mainly in speculative trading (Mei, Scheinkman, &

Xiong, 2009; Wang, Shi, & Fan, 2006). This speculative trading is the result of strict short-sale

constraints and the presence of less experienced individual investors, who have heterogeneous beliefs

about stock prices (Mei et al., 2009).

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