Information in Stock Prices: Buy the Rumor, Sell the News?

Abstract

The popular adage, “buy the rumor and sell the news,” can apply to only half of stock trades, because someone must be on the other side of every trade, a party who is “buying the news.” The “news” in this study comes from changes in analyst recommendations, which cause measurable changes in stock prices. On average, analyst upgrades are accompanied by one-day abnormal returns of 1.96 percent, while analyst downgrades lead to one-day abnormal returns of -1.83 percent. Examining the trading patterns of four types of traders, the study finds that active institutional traders are best at buying a stock in the few days before an analyst upgrade (i.e., buying the rumor) and selling it on the upgrade day (selling the news). To a lesser extent, active institutional traders also sell before downgrades, while buying back on downgrade days. In contrast, program institutional traders are typically on the losing side of these trades, while market makers are generally not involved and individuals make only small investment changes. Based on 15,101 analyst upgrades and 15,907 analyst downgrades for 2,122 different NYSE-listed stocks, the study concludes that active managers can add value by trading on research (their own or that provided by sell-side analysts), which suggests that including some actively managed funds can make sense for retirement plans at hospitality firms. Looking specifically at changes in analyst recommendations for publicly traded hospitality firms, the same patterns hold, with average one-day abnormal returns of 1.98 percent on analyst upgrades and -1.79 percent on analyst downgrades and similar “buy the rumor, sell the news” trading patterns by active institutional investors around analyst recommendation changes.