The Determinants of Informed Trading:

Implications for Asset Pricing

Hadiye Aslan
University of Houston

David Easley
Cornell University

Soeren Hvidkjaer
University of Maryland

Maureen O’Hara
Cornell University

This draft: November 30, 2006

We would like to thank K.C. Chan, John Griffen, Inmoo Lee, seminar participants at the
University of Texas (Austin), National University of Singapore (NUS) and conference
participants at the International Conference on Finance, University of Copenhagen for
helpful suggestions.
 The Determinants of Informed Trading: Implications for Asset Pricing

1. Introduction
Microstructure research has increasingly focused on the important real effects of
microstructure variables. While traditionally such research delineated the influence of
microstructure on market variables, more recent research has shown that microstructure
can explain a variety of effects due to its role in influencing the liquidity and price
discovery of assets. Thus, microstructure research has evolved from determining trading
costs and spreads to providing insights into capital structure and asset pricing. Similarly,
researchers in other areas, most notably asset pricing, are increasingly investigating a
broader set of factors thought to affect asset market behavior. Asset pricing researchers
have found success augmenting traditional measures of market risk with both accounting
data and microstructure variables. Thus, asset pricing research has evolved from simple
market risk models to complex factor models based on accounting and market data.
In this paper, we investigate the linkage of microstructure, accounting and asset
pricing. While distinct in many ways, the literature in each of these areas tries to
understand the behavior and pricing of financial assets. As we demonstrate in this paper,
one unifying influence on these areas is the critical role played by information.
Microstructure models (see Easley, Kiefer, O’Hara [1998]) provide a measure of private
information-based trading, the PIN measure, that has been shown to explain asset returns.
PIN is derived from market trade data, but it is fundamentally a proxy for a firm’s
information environment. Accounting and other market data also provide measures of a
firm’s information environment. Thus, accounting variables, Tobin’s Q, and industry
variables are widely used to measure a firm’s economic performance and characteristics,
and they have also been shown to matter for asset pricing. The questions we address in
this research are how does PIN relate to these accounting variables, and what does this
tell us about asset pricing?
There are three important reasons for pursuing this agenda. First, linking PIN and
accounting measures allows us to develop operational measures for informed trading and
information risk. Information risk arises when some investors have better information

2
than others about a firm’s prospects. How large this risk is depends upon a variety of
factors such as the nature and quality of a firm’s accounting information, the availability
of public information sources about the firm, the frequency of new information events,
and the fraction of traders who have better information. The accounting and finance
literatures have employed a number of proxies for private information (for example
analyst coverage, and abnormal accruals), but these measures do not include the market
information captured by PINs. Understanding the determinants of PINs provides insights
into what kinds of firms have higher information risk, and how this information risk is
affected by particular firm characteristics, accounting treatments, or even regulatory
changes.
Second, finding the economic determinants of PIN allows us to determine a proxy
for PIN. PIN measures are derived from trade data, and their estimation requires using
tick-by-tick data to determine trade imbalances and activity. Recent structural changes in
the market, however, have greatly reduced market depth and consequently increased the
number of trades in active stocks. Such massive volume has severely compromised the
maximum likelihood estimation technique needed to estimate PINs for active stocks. The
technique we develop in this paper provides a mechanism to overcome this problem by
developing a proxy for PIN, denoted PPIN. Such PPINs may be both easier to estimate
and more widely applicable to a range of firms and markets.
Third, developing PPINs allows us to investigate the role of information risk in
asset pricing using longer time periods. Easley and O’Hara [2004] demonstrate
theoretically why information risk should affect asset returns, and Easley, Hvidkjaer and
O’Hara (2002, 2004) provide strong empirical evidence in support of this effect. These
empirical studies have limited sample periods, however, due to the unavailability of high
frequency data in the U.S. before 1983. Using the PPIN technique developed here, we
can estimate PINs over earlier time periods, allowing us to investigate the time spans
typically employed in long horizon asset pricing studies. Our conjecture is that some of
the variables found to matter for asset pricing are actually proxying for information risk,
and our analysis here provides a way to investigate this hypothesis.
Our approach in this paper involves first finding the cross-sectional determinants
of PIN using firm level accounting and market data. We use a time-series of PINs

3
estimated from market data from the period 1983-2001, and we regress those PINs on a
wide variety of firm and industry specific variables suggested by the accounting and asset
pricing literatures. Our analysis reveals a number of intriguing relationships between
informed trading and industry structure, as well as with variables such as age, size,
growth, profits, insider holding, institutional trading, and accruals.
We then use these data to create an instrument for PIN, the PPIN, which we can
estimate from these firm-specific data. Our goal here is to create an instrument that has
explanatory power for the cross-section of stock returns. We provide a number of
diagnostic tests to evaluate the efficiency of the PPIN, and we show that PPINs are a
successful proxy for PIN variables. Of particular importance, we find using in-sample
asset pricing tests that PPINs perform as well as PIN variables.
This sets the stage for our analysis of the role of information risk in asset pricing.
We construct a time-series of PPINs for each sample firm over the time period 1965-
2004. We then use our PPINs as explanatory variables in the standard asset pricing
regressions. The asset pricing literature has suggested a wide variety of variables
believed to explain asset returns. These include size and book to market (Fama and
French [1998]), turnover (Chordia, Subrahmanyam, and Anshuman [2001]) and
momentum (Jegadeesh and Titman [1993]; Carhart [2002]; Grundy and Martin [2000]).
We test two hypotheses: first, is information risk priced in asset returns?; and second,
does information risk vitiate the influence of other variables on asset returns?
We find that information risk as captured by PPINs is both statistically and
economically significant for asset prices. Using a variety of specifications, we find the
PPIN is always positive and significant, and that it is robust to the inclusion of
explanatory factors such as Beta, SIZE, and Book-to-Market as well as to Momentum.
We also show that the PIN effect is robust to measures such as dollar volume and
turnover, but that these measures are not robust to PIN, suggesting that it is information
and not illiquidity that matters for asset returns. Turning to our second hypothesis, we do
not find evidence that PIN vitiates the role of other variables, although it does weaken
their influence. Thus, our results suggest that the SIZE effect arises for reasons other
than information difference across firms.

4
 This paper is organized as follows. The next section discusses the nature of
information risk, the role of public and private information, and the disparate approaches
taken in the accounting and microstructure literatures to measure private information.
This section also sets out the derivation and estimation of PIN variables. Section 3
presents the data and sample. Section 4 investigates the economic determinants of PIN.
Section 5 investigates asset pricing and information risk over both short and long sample
periods. This section also discusses methodological issues connected with our analysis.
Section 6 is a conclusion.

2. Information Risk and PIN

Standard asset pricing models accord no role to information in affecting a firm’s
cost of capital. This is because theoretical asset pricing analyses consider a homogeneous
investor world in which the effect of differences in beliefs on asset prices cannot be
analyzed. The standard asset pricing empirical literature builds from this idealized view
of the economy, and it does not consider the possibility of information affecting beliefs,
and thus prices and returns on assets. In this world, the representative individual is
compensated only for holding aggregate risk, idiosyncratic risk need not be held, and so
in equilibrium there is no compensation for holding it.
If investors have differential information, however, they will have heterogeneous
beliefs, and they may have differing views of aggregate and idiosyncratic risk. In
equilibrium, even fully rational, but differentially informed, investors will see differing
returns to assets, and they will hold different portfolios. Easley and O’Hara [2004] build
on the classic rational expectations analysis of Grossman and Stiglitz [1980] to show how
these differing portfolio choices resulting from differential information change returns.1
To see how prices are affected by private information, consider an uninformed investor
faced with a choice between two assets which are identical except that one asset has less
public information and more private information. The uninformed investor loses to the
informed investors who know the private information, and so requires a greater expected
return to hold the asset with more information risk. Easley and O’Hara [2004] show that

1
See also Admati [1985] who analyzes the CAPM in an asymmetric information world.

5
assets with more private, and less public, information should have greater expected
returns.2
Both the market microstructure literature and the accounting literature have
offered empirical support for the claim that differential information matters for returns.
In the microstructure literature the most direct support for this idea comes from Easley,
Hvidkjaer and O’Hara [2002]. They measure the probability of information-based trade
using microstructure data and find that a 10 percentage point increase in the probability
of information based trade leads to a 2.5% increase in expected returns. An alternative
approach is taken by Amihud and Mendelson [1986, 1989] who show that firms with
greater spreads have a greater cost of capital. Their analysis suggests that firms can
reduce the spread by proving public information.
In the accounting literature, a number of variables have been found to be related
to the cost of capital. Botosan (1997) shows that for a sample of firms with low analyst
following greater disclosure of information reduces the cost of capital by an average of
28 basis points. Botosan, Plumlee and Xie [2004] find that proxies for information
precision affect the cost of equity capital. Francis, Lafond, Olsson and Schipper (2004,
2005) show that firms with lower quality earnings, measured primarily by abnormal
accruals, have a higher cost of capital.3 Numerous accounting studies have documented
the effect of information disclosure on returns, see Healy and Palepu [2001] for a survey
of the empirical work and Verrecchia [2001] for a survey of the theoretical work on this
topic.
Our goal in this research is to relate our measure of private information based
trading, PIN, to these, and other accounting measures, which might affect the cost of
capital. PIN variables are derived from trade data, and essentially use the pattern and
volume of buys and sells to infer the presence and frequency of information-based trades.
An advantage of this approach is that it uses market data to infer information risk for a
specific firm. A limitation of this approach, however, is that it does not use firm-specific
variables such as accounting treatments, economic performance metrics, or outside

2
Diamond and Verrecchia [1991] consider an alternative mechanism by which information can affect
returns by analyzing how disclosure affects the willingness of market makers to provide liquidity for a
stock.
3
An alternative view is found in Cohen [2005] who finds that firms providing higher quality financial
information do not exhibit a lower cost of capital.

6
analyst coverage that might naturally be expected to relate to the firm’s information
environment. Blending these approaches allows us to use both sources of information to
measure a firm’s information risk.4 We show how to construct a proxy for PIN from
accounting and market measures which we then use to explain expected returns.

B. The Derivation and Estimation of PIN Variables

We now set out a methodology for estimating the risk of private information-
based trading. This approach uses a structural microstructure model to formalize the
learning problem confronting a market maker in a world with informed and uninformed
traders. In a series of papers, Easley et al demonstrate how such models can be estimated
using trade data to determine the probability of information-based trading, or PIN, for
specific stocks. The rest of this section sets out this approach, drawing heavily from
Easley, Hvidkjaer, and O’Hara [2002]. Readers conversant with the PIN methodology
can proceed directly to the next section.
Microstructure models depict trading as a game between the market maker and
traders that is repeated over trading days i=1,…,I. First, nature chooses whether there is
new information at the beginning of the trading day, and these events occur with
probability α. The new information is a signal regarding the underlying asset value,
where good news is that the asset is worth ⎯Vi, and bad news is that it is worth Vi. Good
news occurs with probability (1-δ) and bad news occurs with the remaining probability,
δ. Trading for day i then begins with traders arriving according to Poisson processes
throughout the day. The market maker sets prices to buy or sell at each time t in [0,T]
during the day, and then executes orders as they arrive. Orders from informed traders
arrive at rate µ (on information event days), orders from uninformed buyers arrive at rate
εb and orders from uninformed sellers arrive at rate εs. Informed traders buy if they have
seen good news and sell if they have seen bad news. If an order arrives at time t, the
market maker observes the trade (either a buy or a sale), and he uses this information to

4
See also Botosan and Plumlee [2003] who use PIN measures to proxy for information dispersion across
traders in a study of information attributes and accounting based measures of the expected cost of equity
capital

7
update his beliefs. New prices are set, trades evolve, and the price process moves in
response to the market maker’s changing beliefs. This process is captured in Figure 1.
The structural model described above allows us to relate observable market
outcomes (i.e. buys or sells) to the unobservable information and order processes that
underlie trading. The likelihood function for trade on a single trading day that is implied
by this model is
ε bB ε sS
L(θ | B, S ) = (1 − α )e −ε b e −ε s
B! S!
ε B
(µ + ε s ) S
(1) + αδe −ε b b
e − ( µ +ε s )
B! S!
( µ + ε b ) B −ε s ε sS
+ α (1 − δ )e −( µ +ε b ) e
B! S!

where B and S represent total buy trades and sell trades for the day respectively, and
θ = (α, µ, εΒ, εS, γ) is the parameter vector. This likelihood is a mixture of distributions
where the trade outcomes are weighted by the probability of it being a "good news day"
α(1−δ), a "bad news day" (αδ), and a "no-news day" (1−α).
Imposing sufficient independence conditions across trading days gives the
likelihood function across I days
I
(2) V = L(θ | M ) = ∏ L(θ | Bi , S i )
i =1

where (Bi, Si) is trade data for day i = 1,…,I and M=((B1,S1), …,(BI,SI)) is the data set.5
Maximizing (4) over θ given the data M thus provides a way to determine estimates for
the underlying structural parameters of the model ( i.e. α, µ, εΒ, εS, δ).
This model allows us to use observable data on the number of buys and sells per
day to make inferences about unobservable information events and the division of trade
between the informed and uninformed. In effect, the model interprets the normal level of
buys and sells in a stock as uninformed trade, and it uses this data to identify the rates of
uninformed order flow εΒ and εS. Abnormal buy or sell volume is interpreted as
5
The independence assumptions essentially require that information events are independent across days.
Easley, Kiefer, and O’Hara (1997b) do extensive testing of this assumption and are unable to reject the
independence of days.

8
information-based trade, and it is used to identify µ. The number of days in which there
is abnormal buy or sell volume is used to identify α and δ. Of course, the maximum
likelihood actually does all of this simultaneously.
The estimation of the model's structural parameters can be used to construct the
probability that an order is from an informed trader, known as a PIN. In particular, given
some history of trades, the market maker can estimate the probability that the next trade
is from an informed trader. It is straightforward to show that this probability of
information-based is given by

αµ
(3) PIN =
αµ + ε S + ε B

where αµ + εS+ εB is the arrival rate for all orders and αµ is the arrival rate for
information-based orders. PIN is thus a measure of the fraction of orders that arise from
informed traders relative to the overall order flow.
Because PIN variables provide a direct measure of the risk of information-based
trading, they are useful in addressing a wide range of microstructure issues. For example,
in the standard microstructure model with competitive, risk neutral market makers, the
opening spread is directly related to PIN.6 Other uses of PIN have been to assess
differential information of order flows across markets, to ascertain whether local or
foreign investors trade more on private information, and to investigate the information
content of foreign exchange trading, to name but a few applications. Of particular
importance for our study here is that PIN as been shown to matter for asset pricing, an
issue we return to in Section 5. In the next section we turn to the estimation of PINs and
to the data we use in our analysis.

6
In particular, in the case where the uninformed are equally likely to buy and sell (εb= εs= ε) and news is
equally likely to be good or bad (δ = 0.5), the percentage opening spread is
Σ (V − V i )
= ( PIN ) i
V *i V *i
where V*i is the unconditional expected value of the asset given by V*i = δVi + (1-δ)Vi. Note that if PIN
equals zero, either because of the absence of new information (α) or traders informed of it (µ), the spread is
also zero. This reflects the fact that only asymmetric information affects spreads when market makers are
risk neutral.

9
3. Data and Sample

We estimate our model for the sample of all ordinary common stocks listed on the
New York Stock Exchange (NYSE) and the American Stock and Exchange (AMEX) for
the years 1983 to 1999. We exclude real estate investment trusts, stocks of companies
incorporated outside of the United States, and closed-end funds. Also, we include only
stocks which have at least 60 days with trade or quote data in a given year. This leaves us
with a sample of between 1858 and 2371 stocks to be analyzed each year.

A. The PIN estimation

The likelihood function given in equation (2) depends on the number of buys and
sells each day for each stock. To construct this data, we first extract transactions data
from the Institute for the Study of Security Markets (ISSM) and Trade And Quote (TAQ)
datasets. The ISSM and TAQ data provide a complete listing of quotes and trades for
each traded security. For our analysis, we require the number of buys and sells for each
day, but the data record only transactions, not who initiated the trade. To sign trades as
buys or sells, we use the standard Lee and Ready (1991) algorithm. Trades at prices
above the midpoint of the bid-ask intervals are classified as buys, and trades below the
midpoint are classified as sells. Trades occurring at the midpoint of the bid and ask are
classified using the tick test, which compares the price with the previous transaction price
to determine the trade direction. We apply this algorithm to each transaction in our
sample to determine the daily numbers of buys and sells. Using a maximum likelihood
procedure, we estimate the structural parameters of the model, Θ = (α , µ , ε B , ε S , δ ) ,
simultaneously for each stock separately for each year in the period. The maximum
likelihood estimation converges for 98.8 percent of the stocks in our sample. However,
in stocks with very large number of trades, the optimization program encounters
computational underflow, and we are unable to evaluate the likelihood function for those
stocks.

10
B. The explanatory variables
We obtain data from several sources. Data on firm characteristics, returns and
standard accounting variables come from the monthly CRSP and the annual
COMPUSTAT files. SIZE is the logarithm of market value of equity in firm i at the end
of year t, STDEV is the annualized standard deviation of daily returns for firm i in year t.
TURNOVER represents the number of shares traded divided by the number of shares
outstanding, share turnover, for firm i in year t. AGE represents the number of years since
the stock i was first covered by CRSP. We take the logarithm of SIZE, STDEV,
TURNOVER, and 1+AGE, denoted LSIZE, LSTDEV, LTURNOVER, and LAGE,
respectively. GROWTH is the percentage increase in sales (item 12) from year t-1 to year
t. We measure the return on assets, ROA, as the ratio of operating income after
depreciation income before extraordinary items to the book value of assets (item 178/
item 6). Tobin's Q is defined as the market value of the firm's assets divided by the
replacement costs of the assets. We construct Tobin’s Q, TOBIN, as the market value of
assets divided by the book value of assets, where the market value of assets equals the
sum of book value of assets and the market value of common equity (item 60) less the
book value of common stock and balance sheet deferred taxes (item 74). To avoid
spurious inferences, TOBIN, GROWTH and ROA are winsorized at the top and bottom
one percent of their respective distributions because these variables take extreme values
for some firms.
ACCRUALS is the estimate of the discretionary component of total accruals based
on Jones’ (1991) model which maps current period working capital accruals into
operating cash flow realizations. Recently, Francis, Lafond and Olson (2004, 2005) have
used this metric as a proxy for the information risk. Specifically, for each of the 48 Fama-
French (1997) industry definitions, we run the following regression for each industry and
for each year t:
TAi ,t 1 ∆ Re vi ,t PPEi ,t
(4) = φ1 + φ2 + φ1 + ε i ,t
Asseti ,t −1 Asseti ,t −1 Asseti ,t −1 Asseti ,t −1

The variable TAi ,t is the total accruals which are defined as equal to

( ∆CAi ,t − ∆CLi ,t − ∆Cashi ,t + ∆STDEBTi ,t − DEPN i ,t ), where ∆CAi ,t is the firm i’s change

11
in current assets (item 4) between year t-1 and year t, and ∆CLi ,t is firm i’s change in

current liabilities (item 5) between year t-1 and year t. ∆ Re vi ,t is firm i’s change in

revenues (item 12) between year t-1 and year t, ∆PPEi ,t is firm i’s gross value of

property plant and equipment (item 7) in year t and Assetsi ,t −1 is firm i’s total assets at

the beginning of year t. The industry- and year- specific parameter estimates from
equation (4) are used to obtain discretionary accruals:
TAi ,t
(5) ACCRUALSi ,t = − NAi ,t
Assetsi ,t −1

1 (∆ Re vi ,t − ∆ARi ,t ) ˆ PPEi ,t
where NAi ,t = φˆ1 + φˆ2 + φ1 + ε i ,t is the normal
Asseti ,t −1 Asseti ,t −1 Asseti ,t −1

accruals for firm i in year t and ∆ARi ,t is the firm i’s change in accounts receivable (item

2) between year t-1 and year t. Following Francis et al (2004, 2005), we use the absolute
value of this measure, |ACCRUALS|, in our empirical analyses.
PERINST represents the institutional ownership as a fraction of shares
outstanding. Our institutional holdings data consists of end-of-year total institutional
stock holdings for every publicly traded U.S. firm between 1980 and 1999. We obtain the
data from Thompson Financial, which gathers the information from institutional 13F SEC
filings. All institutions with holdings of $100 million or more under management are
required to file. The filings are submitted quarterly and include institutional holdings in
every U.S. firm, as long as the holdings are more than $200,000 or 10,000 shares. We
combine the institutional holding data with the CRSP data, and if a firm in CRSP cannot
be matched with the 13F data, we assume that the institutional holdings are zero.
We obtain data on analyst coverage, ANALYST, from the I/B/E/S Historical
Summary files. For each stock i on CRSP/COMPUSTAT merged data, we measure the
analyst coverage for firm i in any given year t as the number of analysts who provide
fiscal-year-1-ahead earnings estimation for this particular firm. If no I/B/E/S value is
available (i.e., CRSP is not matched with I/B/E/S data), we set coverage equal to zero.
We use the logarithm of 1+ANALYST, LANALYST, in the analysis below.
Finally, PERINSIDER represents the fraction of shares outstanding held by
company insiders. The Securities Exchange Act of 1934 requires all officers, directors,

12
and holders of ten percent or more of the company’s stock to report their trades within 10
days after the end of month in which the security trade took place.7 For the purpose of our
analysis, insiders are defined as officers and directors. While large shareholders are
required to report their trades to the SEC, they are not directly involved in the day-to-day
operations of the firm and less likely to have access to superior information. The insider
data used in this analysis come from two different sources. For the period of 1983-1986,
the data are obtained from the U.S. Securities and Exchange Commission’s (SEC)
Ownership Reporting System (ORS) tapes. The 1987-1999 data are obtained from the
Insider Filing Data provided by Thompson Financial. We compute yearly holdings data
as the average of the holdings at the beginning and at the end of each year. If we cannot
find a match with the CRSP data, we assume the insider holdings are zero. Our final
sample has 35,722 firm-years of data.

C. Summary statistics and correlations

Table 1 provides summary statistics on the variables listed above. The accounting
and market variables all have sensible means, with some of the variables exhibiting vary
large divergences across the firms in our sample. The estimated PIN variable is
statistically significant, with a mean of 0.211 and a standard deviation of 0.076. The
PINs range from 0.039 to 0.705, suggesting a wide diversity in the probability of
information-based trading across the stocks in our sample.
The simple correlations in Table 2 provide some first insights into the relationship
between PIN and these accounting and market variables. PIN is positively correlated with
the percentage of Insider Holdings, with Accruals, and with Standard Deviation. These
findings seem sensible, as firms with more insider holdings are more likely to have more
asymmetric information. Similarly, the accounting literature has used accruals as a
measure of asymmetric information, an interpretation consistent with our finding here.
PIN and Size are strongly negatively correlated, a result also found in earlier work (see
Easley et al [2002]). This is consistent with private information being a more important
property of small firms. PIN is also negatively correlated with firm Age, Analyst

7
Since the enactment of Sarbanes-Oxley in July 2002, insiders have been required to report their trades by
the second business day following the trade.

13
Coverage, and Turnover. Each of these variables is positively correlated with SIZE,
suggesting that older, larger firms have more analyst coverage and greater trading
volume. Institutional holdings and PIN are also negatively correlated, while such
holdings are positively correlated with Size and Turnover. Finally, PIN has a small
negative correlation with Tobin’s Q, with Growth, and with ROA.

4. Economic Determinants of PIN: Accounting and Market Variables

The analysis above suggests that the probability of information-based trading as

measured by PIN exhibits sensible, albeit potentially complex relationships with
accounting and market data typically used to measure firm characteristics and
performance. In this section we investigate these relationships more fully by considering
the economic determinants of PIN. In particular, we are interested in finding the set of
accounting and market variables that best explain PINs, allowing us to determine what
types of firms have high information risk. We then use these variables to create a proxy
for PIN based on accounting and market data.

A. Cross-Sectional Regressions
We first investigate the determinants of PIN using cross-sectional regressions
over the sample period 1983-1999. In each year we have a PIN estimate for each firm in
our sample, yielding 35,722 firm-years of data. We analyze this data using both pooled
regressions and Fama-MacBeth (1973) regressions. The pooled regressions use OLS
estimation over the entire firm-year sample, while the Fama-MacBeth approach uses
yearly regressions, and then averages the estimated coefficients over the sample period.
The estimating equation is given by:

PINt = α1 + a2LNSIZEt + a3GROWTH +a4LAGE + a5LANALYST + a6LTURNOVER +

a7PERINSIDER + a8PERINST + a9ACCRUALS + a10ROA + a11STDEVt + a12Tobint + nt

Table 3 presents the results of these cross-sectional regressions. All explanatory

variables in the regressions are normalized by their cross-sectional means and standard
deviations each year. This allows one to interpret the coefficients as the marginal effect

14
on PIN of a one standard deviation move in the explanatory variable. As the results from
the two approaches are virtually identical, we focus our discussion on the Fama-MacBeth
estimates. The data show that most, but not all, of our explanatory variables have a
statistically significant effect on PIN. Size and AGE are both strongly negatively related
to PIN, consistent with larger, older firms having less private information. Analysts also
has a strong, negative relation, suggesting that firms with greater analyst following have
lower information risk. Earlier work (see Easley et al [2000]) suggests that analysts may
serve to turn private information into public information, a result consistent with our
finding here. Additionally, analysts may attract additional uninformed order flow to a
stock, an effect that would also reduce the information risk of a stock. Turnover is also
negatively related to PIN, again consistent with the notion that stocks with greater trading
activity tend to have more uninformed order flow.
The percentage of Insider Holding continues to be positively related to PIN, and
now, too, so is the percentage of Institutional Holdings. The issue of who are informed
traders is a question of perennial interest in microstructure, and our results here accord
well with the general view that it is insiders and institutional traders who are more likely
to be acting on private information. Profitable firms (as captured by ROA) and high
growth firms also have higher PINs, consistent with informed traders seeking out such
firms due to their high potential for returns to information-based trading. A similar
explanation may attach to the positive relation between Standard Deviation and PIN, as
firms with greater volatility present greater profit opportunities for informed traders. As
was found in the simple correlations, Tobin’s Q is negatively related to PINs. Accruals,
however, exhibit no statistically significant effect, a somewhat surprising result given the
extensive use of this variable in accounting as a proxy for asymmetric information.
The results in Table 3 are consistent with high information risk firms being
younger, smaller, less covered by analysts, higher profit, growth and volatility firms. In
addition, such high information risk firms are more widely held by insiders and
institutions. While the data indicate a role for all of these factors, the most significant
influence is that of Size. Smaller firms have higher PINs, suggesting that the information
structure of smaller firms may differ in important ways from that of larger firms.

15
B. The Role of Size
To investigate these size effects more fully, we ran our estimating equation
separately for the smallest 50% of firms and for the largest 50% of firms. The results are
given in Table 4. Looking first at the smallest firms, Panel A shows that Size remains
very significant and negative, but less so than before. ROA, or profitability, also
continues to have a significant, positive effect on PINs. Age, however, now has an
insignificant role, as does Standard Deviation and Tobin’s Q. Accruals, also, are not an
important determinant of information risk for smaller firms.
Both institutional and insider holdings have significant positive influences on
small firm PINs, but this effect is not found with large firms. As Panel B indicates, for
large firms insider holdings remain significantly positive, but this effect is greatly
attenuated for institutional holdings, where it is now only marginally significant. These
findings suggest that institutions play very different roles with respect to small and large
firms. Conversely, Standard Deviation has a strong, positive effect on PIN for large
firms, in contrast with an insignificant role for small firms, while ROA matters for small
firms, but not for large ones. The negative effect of Size is even greater for large firms,
further amplifying our result that information-based trading is a greater risk for small
firms. Again, we find that accruals are not significantly related to PINs for either large or
small firms.
These results demonstrate that the risk of information-based trading as captured
by PIN has a well-defined relation with firm-specific accounting and market data. That
this relationship differs between large and small firms is consistent with there being
greater public information available for large firms, and greater private information for
small firms. This difference in information composition is predicted to matter for asset
returns, an issue we address later in the paper.

C. Time-period Effects
The dramatic changes in both the market and the economy over our sample period
lead to a natural concern that the information environment surrounding firms might be
affected, resulting in temporal instability of our estimates. To address these concerns, we

16
ran our estimating equation over the sub-periods 1983 – 1990 and 1991-1999. The
results are given in Table 5.
Most of the estimated relationships are stable across both sub-periods, although
there are a number of exceptions. Age, for example, is significant only in the later
period, a pattern also exhibited by the Growth variable. The coefficients suggest that
younger, faster growing firms had higher information risk in our later period, results that
are consistent with the aberrant behavior typifying the tech boom. Interestingly, while
both insider and institutional holdings retain consistent signs, insider effects are stronger
in the latter period while institutions are more significant in the earlier time period.
Tobin’s q also only is significant in the early period, where it has a negative sign. Size,
turnover, analysts, ROA and standard deviation all exhibit consistent behavior over both
time intervals.
The behavior of the Accruals variable is particularly intriguing. In our overall
sample results, Accruals was not significant for either large or small firms. Segmenting
by time, however, reveals a very different story. In the early period, Accruals has a
weakly significant negative relation with the PIN measure of information risk. This
changes over time, however, so that in the later period Accruals has a stronger, now
positive relationship with PIN. Accruals have been used in the accounting literature as a
proxy for asymmetric information, a role consistent with our estimates in the later period.
As accounting practices do change over time, these findings suggest that the behavior and
information content of accruals in the 1990’s was very different than it was in earlier
times.

D. Industry Effects
Finally, we consider another likely influence on the information risk of firms by
looking at the role of industry effects. Industry effects can arise for a variety of reasons,
such as correlated information events, industry norms or standards in accounting and
disclosure practices, or the like. It seems likely that the level of information risk should
differ across industries, just as other variables related to risk typically do. Our analysis
thus far has revealed a number of features of high information risk stocks, but we have

17
yet to address the question of whether the stocks in particular industries have higher
information risk.
Using SIC codes, we sorted firms into industries annually from 1983 to 1999
based on the Fama-French 17-industry classification. In Table 6, we report the average
number of stocks assigned to each industry every year, along with the average percentage
of total market capitalization. As is apparent, industries differ in size, with mining and
minerals being the smallest industry (with approximately 25 firms) and banks and other
financials being the largest. Approximately 18% of our sample by market value is
classified into the residual “Other” category. The regression uses indicator variables for
the 16 industries, such that the estimates in Table 6 measure the incremental effect of an
industry relative to the “Other” category.
Because PIN variables measure the risk of information-based trading, we would
expect stable, less dynamic industries to exhibit lower PINs, and more volatile industries
to have the opposite result. This is exactly what we find. Utilities exhibit a very strong,
negative relation with PIN, consistent with there being little asymmetric information in
this industry. Conversely, strong positive relations with PIN are connected with firms in
Oil and Petroleum Products, Construction, Textiles, and Retail. A number of basic
industries, for example Autos, Food, Chemicals, and Steel, have PINs which are not
significantly different from those of the baseline “Other” category.

E. Summary – What types of firms have high information risk?

Overall, our analysis provides a clear profile of the types of firms with greater
information risk. Smaller, younger firms are more likely to have higher information risk,
as are faster growing and more profitable firms. Firms with more insider holdings and/ or
greater institutional holdings are also subject to greater information-based trading,
consistent with the general view that insiders and institutions are more likely to be
informed traders. Firms followed by few analysts also generally have high information
risk, as do firms with lower Tobin’s q. Information risk is also higher in firms with low
turnover, and in firms with high abnormal accruals in the 1991-1999 period. Finally,
transportation, textile, retail, and business machinery and equipment firms are also more
likely to have higher information risk as captured by the PIN variable.

18
 As noted earlier, one goal of this research is to relate the trade-based measures of
information-based trading from microstructure analyses to the more accounting-based
measures often used to describe a firm’s information and economic environment. Our
analysis above shows that we can successfully characterize the economic determinants of
PIN, allowing us to determine what sorts of firms have higher information risk. We now
turn to a second goal of our analysis which is investigating how this information risk
affects asset pricing.

5. Asset Pricing and Information Risk

Asset pricing analyses generally rely on long sample periods to investigate the
influence of various factors on cross-sectional returns. As noted earlier, a limitation of
PIN measures is that the trade-based data needed to construct PIN is not available prior to
1983. Thus, analyses of the role of information risk in asset pricing have been limited to
only relatively short sample periods starting in 1983, as opposed to studies such as Fama
and French who use data onwards from 1965. In this section, we address this problem by
drawing on the economic determinants of PIN to form a proxy for a firm’s information
risk. Our particular analysis focuses on two questions: First, can we construct an
instrument for PIN that has explanatory power for the cross-section of returns? And,
second, can we use that instrument to extend our sample period and so investigate the
effects of information risk over the time periods typically used in asset pricing studies?

A. Creating PPINs
In principle, the regression analysis of the previous section provides a template
for creating such an economic proxy for the PIN variable. Our analysis requires both
going forward in time to create a PIN proxy for the years 2000- 2004, and backwards to
create PPINs for the years 1965- 1982. Creating PPINs going forward is straightforward,
but a practical problem arises in going backwards because some of the data series in our
regressions (most notably, analysts following and percentage insider and institutional

19
holdings) are not available in earlier time periods.8 To address this concern, we calculate
our PIN proxy (PPIN) using a subset of variables with continuous data series. These
continuous time series, and their associated coefficient variables, are given in Table 7 for
the sample period 1983 - 1999. As is apparent, the coefficients on this restricted set of
variables are consistent with our earlier results, and the relatively high R2 suggests that
PIN variables can be accurately described by a combination of accounting and market
variables.
We now use these coefficient values to create a proxy for PIN, denoted PPIN,
over the time period 1965 -2004. Figures 2 provides a comparison of the distributions of
PPIN and PIN over the sample period 1983 - 1999. As is apparent, the PPIN distribution
is less skewed than the PIN distribution, and it has a smaller standard deviation (σ PIN =
0.076, σ PPIN = 0.045). This is largely due to there being fewer outliers in the estimated
PPINs, a not unexpected result given that PPIN is a composite variable and so more
likely to trend to the mean. The means of the two distributions are statistically the same,
however, with µ PIN = 0.211 and µPPIN = 0.208.
Figure 3 shows the time-series distribution of the PPINs over the entire sample
period 1965-2004. The PPINs are remarkably stable, with mild variability in the
distributions occurring only at the very beginning and the very end of the sample period.
The mean PPIN, captured by the p50 line, is virtually constant over the sample period.
Overall, the estimated PPINs appear to be well-defined and stable, but what is not yet
clear is whether the PPINs actually capture the economic properties of the PINs variables.

B. In-sample Asset pricing

We assess the economic efficiency of the PPINs by investigating how well the PPINs
perform in explaining cross-sectional asset returns. We use a standard Fama-Macbeth
methodology and include as explanatory variables Beta, SIZE, and Book-to-Market (BM)
similar to Fama and French (1992).9 We also augment these variables with a momentum

8
Note, however, that this is not an issue if we are interested in estimated PPINs going forward in time.
Thus, for studies implementing PPINs on more recent data we recommend using the full data set of
variables.
9
The construction of the explanatory variables in the asset pricing regressions is outlined in the Appendix.

20
measure, RET12, based on the previous 12-month return in the stock. These results are
reported in Table 8.
As a natural starting point, Panel A provides cross-sectional asset pricing results
using our PIN variable. These results are similar to those first reported in Easley,
Hvidkjaer and O’Hara (2002), and they show that the PIN variable has a positive and
statistically significant effect on asset returns. This positive role is consistent with
investors demanding a higher return to hold stocks subject to greater information risk.
Note that over this time period, Book-to-Market is significant and positive, Size is
positive but only marginally significant, and Beta is not significant.10 The positive sign
on the SIZE variable is the opposite of that predicted by Fama and French (1993), who
argued that small firms, not large firms, should command higher returns. The
insignificant coefficient on Beta, while inconsistent with standard asset-pricing theory, is
consistent with the findings of Fama and French (1992), Chalmers and Kadlec (1998) and
Datar, Naik and Radcliffe (1998) who investigate similar sample periods. These authors
find, as we do, that market risk is not statistically significant over this period. The Book-
to-Market result is similar to that found by other researchers, most notably Fama and
French.
Panel A also reports the results when a momentum measure is included in the asset
pricing regressions. Momentum has posed a challenge to many asset pricing models, and
a natural concern is that our results may somehow be due to momentum instead of to
information risk. The results show that this is not the case. PIN remains positive and
economically significant, albeit with a slightly smaller coefficient. A similar effect is
found on Book-to-Market. However, including momentum does vitiate the statistical
significance of SIZE, while Beta continues to be not significant.
Having established the asset pricing influence of PIN, we now consider these cross-
sectional asset pricing results using PPINs. For comparison purpose, we present our
results based on PPINs estimated using the full set of variables (Panel B) and the
continuous set of variables (Panel C). Using the full set of variables, Panel B shows that

10
Easley, Hvidkjaer and O’Hara (2002) found no significant effect of book-to-market. In the current
sample, book-to-market also becomes insignificant once we exclude Amex firms, which were not included
in the Easley, Hvidkjaer and O’Hara (2002) sample. This is consistent with Loughran (1997), who finds
that the book-to-market effect is only present in small firms.

21
the PPINs appear to be remarkably robust, exhibiting the same positive coefficient and
even greater statistical significance than the PIN variables. Including momentum has
little effect on the PPINs, suggesting a robustness both to our PIN proxy and to the
influence of information risk on asset pricing. Panel C presents the cross-sectional results
when PPINs are calculated based on the continuous variable set. The results here are
stronger still, with the coefficient on the PPINs again positive and strongly significant in
either specification.
Using PPINs instead of PINs actually strengthens the statistical significance of the
SIZE variable in the results reported in both Panels B and C. This effect may be due to
the reduced volatility of PPIN relative to PIN. Because the composite variable PPIN is
estimated from a variety of information-linked variables including SIZE, there is also the
possible influence of multi-collinearity. We address this concern more fully later in this
section.
We interpret these in-sample results as strong evidence that the PINs and PPINs are
capturing the same fundamental economic influences on asset prices. Moreover, these
results provide strong support for our argument that information risk is an important
determinant of asset prices. The success of our PPIN proxy now allows us to investigate
these information risk effects on asset pricing over a longer sample period. Such long-
sample period tests provide both a more rigorous test of our hypothesis that information
risk matters in asset pricing, and allows comparison of our results to those of more
standard asset pricing models.

C. Information Risk and Asset Pricing: Long Run Results

Table 9 presents results for cross-sectional asset pricing regressions over the sample
period 1965-2004. Our hypothesis is that information risk affects asset returns because
uninformed investors require compensation to hold assets in which there is greater risk of
private information. We test our hypothesis by seeing whether PPIN, our estimated
proxy for information risk, has a significant and positive effect on asset returns. To
capture the variety of influences that are argued to affect asset returns in the literature, we
present results from eight cross-sectional asset pricing specifications.

22
 As a useful preliminary, Figure 4 traces the coefficients over time through plots of the
annual cross-sectional regression coefficients for PPIN, SIZE, Beta Ret12 and Book-to-
Market. All series show some variability, but in general are consistent across the sample
period. The coefficient for the PPIN variable tends to vary across years, with strong
positive values attaching to our information risk variable for most of the period.
Our cross-sectional results are provided in Table 9. We first note that across all
specifications tested in Table 9 the coefficient on PPIN is both positive and statistically
significant. Thus, whether in combination with β, SIZE, Book-to-market, or Momentum,
PPINs exhibit exactly the behavior predicted by our information risk theory. Indeed, our
PPIN results appear to be strongest when we control for β, SIZE, and BM, suggesting
that PPINs are capturing aspects of risk not captured by these other variables. Equally
important, the PPINS are little affected by Momentum, a natural concern given the
robustness exhibited by momentum effects.
Interestingly, over this long sample period, β does not exhibit the expected positive
sign, nor is it statistically significant in any specification. This puzzling result is not
unique to our study, but it does raise concerns about traditional asset pricing models in
which only systematic risk affects asset returns. A popular alternative framework is
suggested by Fama-French [1992] who find that asset returns are influenced by β, SIZE,
and Book-to-Market. We provide results on these variables in Specification 4, with
Specification 2 augmenting these with Momentum. The results show the while β is not
significant, we do find the predicted negative sign on SIZE and positive sign on BM, with
both results statistically significant. Momentum appears to have little effect on these
results.
Including PPIN into the FF-three factor specification (Specification 5) changes these
results, particularly as they relate to the SIZE variable. PPIN is positive and statistically
significant in combination with these variables. Comparing Specification 4 (β, SIZE,
BM) to Specification 5 (β, SIZE, BM, PPIN), we find that including PPIN reduces the
significance of all the three FF variables, and changes the sign of the SIZE and
β coefficients. Such a sign reversal of the SIZE variable has been found by other authors,
most notably Brennan, Chordia, and Subrahmanyam (BCS) [1998], who show that the

23
inclusion of dollar volume (DVOL) changes the sign of the SIZE variable in asset pricing
regressions.
BCS also find that DVOL has significant explanatory power for asset returns, with
high dollar volume stock having low future returns. What accounts for this relationship
is unclear, but BCS argue that one explanation is that DVOL is a proxy for liquidity. A
natural concern is whether our PPIN is capturing a similar effect, and hence not related to
information risk as we conjecture.
To test for these effects, we included DVOL in our asset pricing regressions. Table 9
shows a variety of specifications pairing DVOL with various other explanatory variables.
Several results are noteworthy. First, we find that separately SIZE, DVOL and PPIN are
significantly related to future returns. Again, however, both SIZE and DVOL have the
“wrong” sign, with larger, more liquid stocks found to have greater returns, and not lower
returns as expected. Second, PPIN is positive and statistically significant in all
specifications. Of particular importance is that PPIN is robust with respect to the
inclusion of DVOL, suggesting that PPIN is not acting as a proxy for liquidity effects.
Similar, PPIN is also robust to the inclusion of SIZE and Momentum, suggesting that
PPIN is picking up influences separate from these variables as well. Finally, we note that
DVOL is not robust to the inclusion of SIZE, and that the signs of both variables change
when each is included.
We interpret these results as suggesting that information risk, as captured by PPIN,
does affect asset returns. Our theory suggests that in equilibrium stocks with greater
information risk should have higher expected returns, reflecting the risk that uninformed
traders face in trading stocks with more private information. In every test, we find
PPINs is positively and significantly related to asset returns. standard asset pricing
models.

D. Multi-collinearity Issue
In this subsection we address the possible impact of multi-collinearity between PPIN
and SIZE. Although pairwise collinearity can be determined from viewing a correlation
matrix of the independent variables, correlation matrices will not reveal higher order
multicollinearity. There are several classical tests for diagnosing for higher-order

24
multicollinearity problems, but we focus on the most common test, namely the variance-
inflation factor. Suppose we have a multiple regression model:
y = b' x + u
where y is the intercept, x is a vector of explanatory variables, u is the error term and b is
the vector regression parameters, whose first element is set to 1. Then, the sampling
distribution variance for OLS slope coefficients can be expressed as
1 σ u2
V (b j ) = ×
1 − R 2j (n − 1)S 2j
In this formula, R 2j is the auxiliary regression’s R 2 (i.e., R 2 obtained after regressing

x j on the other x variables in the model), S 2j is the variance of x j  and σ u2 is the

conditional variance of the error term. Note that the variance of b j is used in constructing

the t-ratios that one employs to evaluate significance. This variance is increased if either
σ u2 is large, S 2j is small, or R 2j is large. The first term of the expression above is called

the variance inflation factor (VIF):

1
VIF =
1 − R 2j

As the name indicates, the VIF measures the factor by which the parameter’s variance (in
an orthogonal regression; hence without multicollinearity) is multiplied (i.e., inflated). If
x j is highly correlated with the other x variables, then R 2j will be large, making the

denominator of the VIF small, and hence the VIF very large. This inflates the variance of
b j , making it difficult to obtain a significant t-ratio. To some extent, we can offset this

problem if there is little noise in the dependent variable or alternatively, that the x’s
account for most of the variation in y. Typically, 10 is used as threshold value. As a rule
of thumb, VIF values greater than 10 may merit further investigation. In our tests VIF
values turned out to be less than 10. More specifically, the VIF statistics for Beta, BM,
SIZE and PPIN variables are 1.19, 6.29 and 6.82, respectively.

E. PPIN portfolio returns

25
 The goal of this subsection is to construct characteristic controls for each stock in
our sample. We form characteristic benchmark portfolios each month by sorting stocks
into deciles by the characteristic in question, where within each decile stocks are value
weighted. Stock i is then matched with one of the portfolio based on its characteristic at
time t-1, and the return of the matched portfolio is subtracted from stock i’s return at time
t:
ritc = rit − Rtc,t −1

where rit is the return on stock i, ritc is the characteristic adjusted return in stock i, Rtc,t −1 is
the return on the characteristic–matched benchmark portfolio. Table 10 reports our
results. Unadjusted raw returns to PPIN portfolios increase monotonically, from 0.91%
for the lowest PPIN portfolio to 2.32% for the highest PPIN portfolio, leading a monthly
excess return of 1.40 percent to our arbitrage portfolio (i.e., portfolio 5-1). The second
and third rows give us the market- and size-adjusted returns. There is a clear pattern that
stocks with high PPINs grant higher market- and size-adjusted returns than those with
low PPINs. After adjusting for the market, the arbitrage returns between the top and
bottom portfolios is still economically significant. Similar results apply towards size-
adjusted portfolios; 5-1 portfolio return is 0.93% per month. Overall, our findings are
robust to book-to-market and momentum adjustments, as well.
The sixth row provides the benchmark-adjusted returns following Daniel,
Grinblatt, Titman and Wermers (1997), henceforth DGTW. This method eliminates the
effects of size, book-to-market, and return momentum in the estimated returns to PPIN
portfolios simultaneously. To construct DGTW benchmark portfolios, we start with
ranking all stocks listed in CRSP based on their market capitalization and assigning them
to size quintiles using NYSE size quintile breakpoints. Within each size quintile, we
further rank stocks based on their book-to-market ratios, and assign them to book-to-
market quintiles, yielding a total of 25 size- and book-to-market sorted portfolios. We
further sort stocks in each of 25 portfolios into quintiles, based on the prior 12-month
return of each stock. This results in a total 125 benchmark portfolios. Finally, the last raw
illustrates the DGTW plus industry (DGTWI) adjusted returns. Industry classifications
are same as those specified in Table 6. As the table demonstrates, the results are vigorous
to DGTW and DGTWI adjustments.

26
F. Size and Information
In order to explore in some greater detail the relation between small firm effect
and information effect, we use a portfolio approach. The advantage of portfolio approach
is that it reduces the idiosyncratic noise from the firm level. We use three different
samples for this purpose. Our first sample uses PPIN measure with historical data
covering the time span between 1965 and 2004. The second sample we use analyzes PIN
and size relation between 1983 and 1999. Finally, our third sample uses the same time
span as our second sample but uses PPIN, instead.
We start our analysis with our first sample. We first sort stocks into five quintiles
based on their market capitalization. Then within each quintile, we sort stocks into five
quintiles based on their PPIN measure. These portfolios are rebalanced every month.
Panel A of Table 11 reports average percentage monthly returns within different SIZE
and PPIN groups. Information effect is mostly pronounced in small firms. Within each
size quintile, quintile 5 including the stocks with the highest PPIN measure has a
dramatically higher return. The average returns to PPIN quintile portfolios are
monotonically increasing from 0.97% for the lowest PPIN portfolio to 1.70% for highest
PPIN portfolio. On average, for large and small firm returns varies between 1.04% and
1.84%. The results also indicate very large spread in average returns between the highest
and lowest PPIN portfolios. The 5-1 difference between the highest and lowest
information portfolios ranges from 0.25% for the large stocks to 1.82% for small stocks,
averaging 0.73% per month, both statistically and economically significant. Our results
show that information effect dominates the size effect in magnitude across portfolios.
We repeat this exercise for our second and third samples including PIN and PPIN
measures. The results in Panels B and C of Table 11 display similar behavior to historical
PPIN portfolios except for that the magnitude of portfolio returns are somewhat smaller.
For example, the mean return to 5-1 PIN and PPIN portfolios are 0.27% and 0.53% per
month, respectively, and highly significant. Furthermore, the average spread to size
portfolios becomes positive, 0.32% in our second sample and 0.16% in our third sample.
This indicates that large firms grant higher returns than small firms, on average. This is
consistent with the argument that small stock premium has largely disappeared since

27
1981. However, whether this is a long term shift in the small stock premium or just a
temporary dip is still being debated.
Next, we re-run Fama-Macbeth (1973) in-sample and long-run regressions for our
size quintiles. The results are provided in Table 12. The last two columns of the table
report the mean estimates of Beta, Bm and PIN parameters whereas Panels second-fifth
columns provide the results for Beta, Bm and PPIN coefficients across size quintiles
using in-sample and historical data. Overall, our findings are in line with the results
provided in tables 8 and 9. Both PIN and PPIN are economically and statistically
significant.

6. Conclusion
The Probability of Information based Trade variable (PIN) is created from trade
data using our structural model relating observable buys and sells to the unobservable
variables that makeup PIN. One contribution of this paper is to provide an independent
verification of our interpretation of PIN. In particular, we show that the correlations
between PIN and other variables that have been used as proxies for a firm’s information
environment are consistent with our interpretation. Smaller, younger firms, firms with
more insider holdings, firms with greater institutional holdings, firms followed by few
analysts and firms in transportation, textiles, retail, and business machinery and
equipment are all more likely to have higher information risk.
Because estimating PIN is difficult with modern data, and impossible before trade
data was first collected in 1983, having a god proxy for PIN for the period before 1983
and for most recent years would be valuable. Our collection of accounting, firm
characteristic and industry characteristic together explain nearly one-half of the variation
in PIN across firms. So we create a proxy for PIN by regressing PIN on these
characteristics. Using the coefficients from this regression, and firm and industry
characteristics, we create a long time series of PPINs. The real test of whether PPIN is
actually a good proxy for PIN is how effective it is in explaining asset prices. We show
that in fact PPIN is at least as successful as PIN in our within sample asset pricing
regressions.

28
 Since we have a good proxy for PIN, we ask how it performs in long time series
asset pricing regressions in which we include periods both before and after the period
used to construct our proxy. Our main conclusion is that our proxy for information-
based-trade, PPIN, performs as expected in asset pricing. Firms with higher PPINs have
a larger cost of capital, and this conclusion is robust to every asset pricing structure that
we have explored. The only other variable that performs consistently well in our asset
pricing investigation is Book-to-Market, all of the other usual variables (beta, size,
momentum, and dollar volume) either are insignificant or have an unexpected sign in the
presence of PPIN. We take this to be strong evidence that PPIN provides a valuable input
into asset pricing.
We believe that our PPIN results provide part of the explanation for why some of
the firm and industry characteristics that other researchers have found useful seem to
work in asset pricing regressions. Our view is that those variables helped to explain asset
prices in part because they were standing in for PIN. Some of these variables may also
play a role that is separate from PIN, in particular they could proxy for the total amount
of information produced about a firm, so it is not necessarily that case that their
effectiveness will vanish once PIN is considered.
It now seems that the state of asset pricing research is to include any variable that
the researcher can somehow justify in an asset pricing regression. All asset pricing
regressions are clearly mis-specified so it is not too surprising that adding explanatory
variables “helps”, but PPIN stands out because of its theoretical underpinnings. We
should note, however, that given how poorly empirical asset pricing works, in particular
that market risk does not seem to priced, any interpretation of coefficients from the asset
pricing literature should be done with great caution.

29
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Fama, E. F., and K. R. French, 1993 “Common Risk Factors in the Return on Stocks and
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Fama, E.F. and K.R. French, 1997, “Industry Costs of Equity,” Journal of Financial
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32
Appendix: Construction of variables in the asset pricing regressions

Because PIN is estimated over the calendar year, we update all yearly variables in
January for the asset pricing tests. PIN estimated in year t-1 is used in the asset pricing
regressions for year t. SIZE is the market value of equity at the end of year t-1. Book-to-
Market ratios are computed in a manner similar to Fama and French (1992), except that
we use book values and market values as of the end of June in year t-1.
We calculate betas using the following approach. Pre-ranking betas are estimated
for individual stocks using monthly returns from at least two years to, when possible, five
years, before the test year. Thus, for each stock we use at least 24 monthly return
observations in the estimation. We regress these stock returns on the contemporaneous
and lagged value-weighted CRSP NYSE/Amex index. Pre-ranking betas are then given
as the sum of the two coefficients (this approach, suggested by Dimson (1979), is
intended to correct for biases arising from non-synchronous trading). Next, 40 portfolios
are sorted every January on the basis of the estimated betas, and monthly portfolio returns
are calculated as value-weighted averages of individual stock returns. Post-ranking
portfolio betas are estimated from the full sample period, such that one beta estimate is
obtained for each of the 40 portfolios. Portfolio returns are regressed on
contemporaneous and lagged values of CRSP index returns. The portfolio beta is then the
sum of the two coefficients. We use individual stocks in the cross-sectional regressions,
so individual stock betas are taken as the beta of the portfolio to which they belong.
Because the portfolio compositions change each year, individual stock betas vary over
time.

33
 Table 1
Summary Statistics

The table contains time series means of cross sectional statistics computed each year in 1983-1999. PIN is
the probability of information-based trading in stock i of year t. SIZE is the market value of equity in firm i
at the end of year t in millions, STDEV is the annualized standard deviation of daily returns for firm i in
year t. AGE represents the number of years since the stock i was first covered by CRSP. TURNOVER
represents the average monthly turnover for firm i in year t. GROWTH is the percentage increase in sales,
ROA is the return on assets, TOBIN is the Tobin’s Q, ACCRUALS is the absolute value of the abnormal
accruals based on the Jones (1991) model. PERINST represents the institutional ownership as a percentage
of shares outstanding, PERINSIDER represents the percentage of shares held by company insiders, and
ANALYST is the number of analysts following stock i in year t.

Mean Std Dev Min. Q1 Median Q3 Max.

PIN 0.211 0.076 0.039 0.158 0.199 0.249 0.705
SIZE 1.612 5.081 0.001 0.063 0.273 1.127 94.245
GROWTH 0.112 0.313 -0.681 -0.016 0.072 0.181 1.771
AGE 20.841 16.933 0.000 8.176 17.382 26.765 66.000
ANALYST 7.237 8.347 0.000 1.000 3.824 11.471 41.588
TURNOVER 0.681 0.623 0.011 0.304 0.534 0.865 10.125
PERINSIDER 0.077 0.144 0.000 0.002 0.015 0.080 1.000
PERINST 0.375 0.240 0.000 0.166 0.363 0.564 0.998
ACCRUALS 0.056 0.048 0.000 0.017 0.041 0.085 0.160
ROA 0.069 0.106 -0.445 0.031 0.078 0.121 0.319
STDEV 0.402 0.268 0.034 0.248 0.340 0.480 4.316
TOBIN 1.324 0.437 0.671 1.002 1.173 1.554 2.227

34
 Table 2
Spearman Correlations

The table shows the time-series means of Spearman rank correlations computed each year 1983-1999. PIN is the probability of information-based trading in
stock i of year t. SIZE is the market value of equity in firm i at the end of year t in millions, STDEV is the annualized standard deviation of daily returns for firm i
in year t. AGE represents the number of years since the stock i was first covered by CRSP. TURNOVER represents the average monthly turnover for firm i in
year t. GROWTH is the percentage increase in sales, ROA is the return on assets, TOBIN is the Tobin’s Q, ACCRUALS is the absolute value of the abnormal
accruals based on the Jones (1991) model. PERINST represents the institutional ownership as a percentage of shares outstanding, PERINSIDER represents the
percentage of shares held by company insiders, and ANALYST is the number of analysts following stock i in year t.

TURN- PER-
SIZE GROWTH AGE ANALYST PERINST ACCRUALS ROA STDEV TOBIN
OVER INSIDER
PIN -0.642 -0.020 -0.266 -0.620 -0.300 0.132 -0.408 0.192 -0.179 0.306 -0.127
SIZE 0.107 0.331 0.874 0.333 -0.130 0.649 -0.276 0.331 -0.464 0.214
GROWTH -0.149 0.082 0.124 0.142 0.112 0.065 0.286 0.006 0.160
AGE 0.284 0.045 -0.134 0.244 -0.199 0.072 -0.317 -0.076
ANALYST 0.425 -0.134 0.658 -0.248 0.262 -0.374 0.137
TURNOVER -0.019 0.485 0.044 0.101 0.222 0.146
PERINSIDER -0.052 0.080 0.094 0.087 0.119
PERINST -0.151 0.294 -0.282 0.098
ACCRUALS -0.119 0.303 0.107
ROA -0.234 0.414
STDEV 0.099

35
 Table 3
Cross-Sectional Regressions

The dependent variable is the probability of information-based trading, PIN, in stock i of year t. LSIZE is
the logarithm of market value of equity in firm i at the end of year t, STDEV is the annualized standard
deviation of daily returns for firm i in year t. LAGE represents the logarithm of 1+the number of years
since the stock i was first covered by CRSP. LTURNOVER represents the logarithm of share turnover for
firm i in year t. GROWTH is the percentage increase in sales, ROA is the return on assets, TOBIN is the
Tobin’s Q, ACCRUALS is the absolute value of the abnormal accruals based on the Jones (1991) model.
PERINST represents the institutional ownership as a percentage of shares outstanding, PERINSIDER
represents the percentage of shares held by company insiders, and LANALYST is the logarithm of
1+number of analysts following stock i in year t. All independent variables are normalized by their yearly
cross-sectional means and standard deviations.

Pooled Regression
Fama-MacBeth estimates estimates
Parameter t-value Parameter t-value
Estimate Estimate

INTERCEPT 20.88 51.38 18.05 125.07

LSIZE -3.51 -16.23 -3.46 -45.19
GROWTH 0.17 2.88 0.20 5.68
LAGE -0.13 -2.34 -0.07 -1.79
LANALYST -0.85 -12.70 -0.90 -12.41
LTURNOVER -1.57 -14.22 -1.54 -34.48
PERINSIDER 0.15 3.54 0.19 5.54
PERINST 0.52 5.29 0.51 10.1
ACCRUALS 0.03 0.73 0.05 1.25
ROA 0.29 5.45 0.32 8.5
STDEV 0.37 3.52 0.38 7.98
TOBIN -0.19 -4.99 -0.22 -5.79

Adjusted R2 0.46 0.47

36
 Table 4
Cross-Sectional Regressions by Firm Size

The dependent variable is the probability of information-based trading, PIN, in stock i of year t. LSIZE is
the logarithm of market value of equity in firm i at the end of year t, STDEV is the annualized standard
deviation of daily returns for firm i in year t. LAGE represents the logarithm of 1+the number of years
since the stock i was first covered by CRSP. LTURNOVER represents the logarithm of share turnover for
firm i in year t. GROWTH is the percentage increase in sales, ROA is the return on assets, TOBIN is the
Tobin’s Q, ACCRUALS is the absolute value of the abnormal accruals based on the Jones (1991) model.
PERINST represents the institutional ownership as a percentage of shares outstanding, PERINSIDER
represents the percentage of shares held by company insiders, and LANALYST is the logarithm of
1+number of analysts following stock i in year t. All independent variables are normalized by their yearly
cross-sectional means and standard deviations.
Panel A: 50% smallest firms by market value
Pooled Regression
Fama-MacBeth estimates estimates
Parameter t-value Parameter t-value
Estimate Estimate

INTERCEPT 24.51 62.69 23.26 95.86

LSIZE -2.41 -13.49 -2.38 -27.73
GROWTH 0.21 2.63 0.26 4.33
LAGE -0.09 -1.04 -0.02 -0.28
LANALYST -0.65 -10.29 -0.68 -8.6
LTURNOVER -2.00 -12.56 -1.95 -27.66
PERINSIDER 0.20 3.03 0.23 4.04
PERINST 0.68 8.91 0.65 8.66
ACCRUALS 0.01 0.11 0.02 0.3
ROA 0.45 5.84 0.51 8.24
STDEV 0.10 0.73 0.10 1.36
TOBIN -0.07 -0.84 -0.05 -0.9

Adjusted R2 0.27 0.26

37
Panel B: 50% largest firms by market value
Pooled Regression
Fama-MacBeth estimates estimates
Parameter t-value Parameter t-value
Estimate Estimate

INTERCEPT 17.26 32.00 12.78 88.27

LSIZE -1.73 -20.44 -1.74 -35.06
GROWTH 0.11 1.75 0.15 4.38
LAGE -0.26 -3.28 -0.26 -6.66
LANALYST -0.69 -10.65 -0.68 -12.95
LTURNOVER -0.79 -7.92 -0.79 -16.88
PERINSIDER 0.12 3.52 0.11 3.11
PERINST 0.17 1.71 0.19 4.20
ACCRUALS 0.01 0.26 0.02 0.64
ROA -0.1 -1.56 -0.14 -3.20
STDEV 0.6 8.42 0.57 12.62
TOBIN 0.01 0.20 0.04 0.94

Adjusted R2 0.39 0.44

38
 Table 5
Cross-Sectional Regressions by Sub-period

The dependent variable is the probability of information-based trading, PIN, in stock i of year t. LSIZE is
the logarithm of market value of equity in firm i at the end of year t, STDEV is the annualized standard
deviation of daily returns for firm i in year t. LAGE represents the logarithm of 1+the number of years
since the stock i was first covered by CRSP. LTURNOVER represents the logarithm of share turnover for
firm i in year t. GROWTH is the percentage increase in sales, ROA is the return on assets, TOBIN is the
Tobin’s Q, ACCRUALS is the absolute value of the abnormal accruals based on the Jones (1991) model.
PERINST represents the institutional ownership as a percentage of shares outstanding, PERINSIDER
represents the percentage of shares held by company insiders, and LANALYST is the logarithm of
1+number of analysts following stock i in year t. All independent variables are normalized by their yearly
cross-sectional means and standard deviations.
Panel A: 1983-1990
Pooled Regression
Fama-MacBeth estimates estimates
Parameter t-value Parameter t-value
Estimate Estimate

INTERCEPT 21.99 82.66 22.70 127.65

LSIZE -3.00 -12.54 -2.99 -25.88
GROWTH 0.06 0.69 0.02 0.38
LAGE 0.02 0.37 0.05 0.78
LANALYST -0.95 -10.82 -0.98 -8.73
LTURNOVER -1.41 -7.33 -1.38 -20.60
PERINSIDER 0.06 0.84 0.07 1.30
PERINST 0.75 6.65 0.75 9.69
ACCRUALS -0.05 -1.14 -0.07 -1.22
ROA 0.37 5.03 0.43 7.03
STDEV 0.42 3.16 0.41 5.82
TOBIN -0.19 -2.66 -0.22 -3.76

Adjusted R2 0.38 0.37

39
Panel B: 1991-1999
Pooled Regression
Fama-MacBeth estimates estimates
Parameter t-value Parameter t-value
Estimate Estimate

INTERCEPT 19.9 35.7 17.96 122.69

LSIZE -3.96 -14.19 -3.89 -38.06
GROWTH 0.27 3.75 0.29 6.44
LAGE -0.26 -4.44 -0.28 -5.77
LANALYST -0.76 -8.15 -0.84 -8.80
LTURNOVER -1.72 -15.87 -1.69 -28.75
PERINSIDER 0.23 6.78 0.23 5.04
PERINST 0.33 2.51 0.31 4.71
ACCRUALS 0.10 1.69 0.12 2.43
ROA 0.23 3.04 0.24 5.04
STDEV 0.33 1.98 0.29 4.66
TOBIN -0.18 -5.11 -0.18 -3.67

Adjusted R2 0.53 0.54

40
 Table 6
Summary Statistics and Regression Results for Industries

Industries are formed annually from 1983 through 1999 based on the Fama-French 17-industry classification. The average number of stocks assigned to each
industry every year is reported, along with the average percentage of total market capitalization. Also reported are the time-series averages of coefficients for the
Fama and MacBeth (1973) methodology along with the pooled regression results.

Pooled Regression
Fama-MacBeth estimates
estimates
Industry Avg. No of Avg. % of Parameter t-value Parameter t-value
Stocks Market Cap. Estimates Estimates
1 Food 70 5.24 0.06 0.35 0.01 0.05
2 Mining and Minerals 37 0.94 -0.08 -0.29 0.00 -0.02
3 Oil and Petroleum Products 114 8.19 0.80 3.02 0.68 4.50
4 Textiles, Apparel & Footwear 76 0.80 0.63 3.06 0.52 2.97
5 Consumer Durables 81 3.86 0.38 1.79 0.27 1.56
6 Chemicals 48 3.40 0.05 0.29 0.10 0.48
7 Drugs, Soap, Perfumes, Tobacco 68 9.57 0.05 0.22 0.07 0.39
8 Construction and Construction 112 2.55 0.45 3.22 0.33 2.08
Materials
9 Steel Works Etc 50 1.06 -0.09 -0.37 -0.13 -0.64
10 Fabricated Products 36 0.58 0.04 0.13 -0.17 -0.71
11 Machinery and Business Equipment 248 8.56 0.07 0.45 0.01 0.08
12 Automobiles 39 2.95 0.36 1.56 0.17 0.72
13 Transportation 72 2.97 0.20 1.35 0.25 1.38
14 Utilities 147 7.81 -1.65 -7.50 -1.69 -10.85
15 Retail Stores 126 5.74 0.57 4.39 0.48 3.42
16 Banks, Insurance Companies, and 324 17.84 -0.22 -1.45 -0.19 -1.13
Other Financials
17 Other 453 17.97

41
 Table7
Cross-Sectional Regressions – Continuous Data

The dependent variable is the probability of information-based trading, PIN, in stock i of year t. LSIZE is
the logarithm of market value of equity in firm i at the end of year t, STDEV is the annualized standard
deviation of daily returns for firm i in year t. LAGE represents the logarithm of 1+the number of years
since the stock i was first covered by CRSP. LTURNOVER represents the logarithm of share turnover for
firm i in year t. GROWTH is the percentage increase in sales, ROA is the return on assets, TOBIN is the
Tobin’s Q, ACCRUALS is the absolute value of the abnormal accruals based on the Jones (1991) model.
All independent variables are normalized by their yearly cross-sectional means and standard deviations.

Pooled Regression
Fama-MacBeth estimates estimates
Parameter t-value Parameter t-value
Estimate Estimate

INTERCEPT 20.92 51.38 18.10 124.97

LSIZE -3.97 -18.18 -3.99 -82.19
GROWTH 0.20 3.44 0.23 6.60
LAGE -0.11 -1.95 -0.06 -1.57
LTURNOVER -1.59 -13.55 -1.56 -39.11
ACCRUALS 0.03 0.81 0.05 1.30
ROA 0.36 5.82 0.39 10.39
STDEV 0.31 3.08 0.32 6.82
TOBIN -0.20 -4.87 -0.22 -5.96
Food 0.03 0.19 -0.04 -0.21
Mining and Minerals -0.19 -0.66 -0.13 -0.54
Oil and Petroleum Products 0.62 2.23 0.49 3.26
Textiles, Apparel & Footwear 0.63 3.02 0.55 3.12
Consumer Durables 0.40 1.85 0.31 1.80
Chemicals 0.05 0.28 0.09 0.43
Drugs, Soap, Perfumes, Tobacco 0.01 0.04 0.04 0.20
Construction and Construction
Materials 0.50 3.53 0.37 2.34
Steel Works Etc -0.02 -0.09 -0.08 -0.36
Fabricated Products 0.14 0.51 -0.07 -0.28
Machinery and Business Equipment 0.10 0.65 0.02 0.20
Automobiles 0.36 1.54 0.17 0.71
Transportation 0.25 1.71 0.29 1.59
Utilities -2.28 -10.06 -2.31 -15.60
Retail Stores 0.64 4.48 0.54 3.83
Banks, Insurance Companies, and
Other Financials -0.23 -1.44 -0.20 -1.19

Adjusted R2 0.45 0.46

 Table 8
In-sample Asset Pricing Tests of PIN and PPIN

The table contains time series averages of the coefficients in cross-sectional asset pricing tests using the
standard Fama-MacBeth (1973) methodology for the sample period 1983-1999. The dependent variable is
the percentage monthly return in excess of the one-month T-bill rate. Betas are portfolio betas calculated
from the full period using 40 portfolios. PIN is the probability of information-based trading in stock i of
year t-1 estimated from trade data. PPIN is the probability of information-based trading in stock i of year t-
1 estimated from trade data. SIZE is the logarithm of market value of equity in firm i at the end of year t-1.
BM is the logarithm of the ratio of book value of common equity to market value of equity for firm i in
year t-1. RET12 is the return in month t-12 to t-1. T-values are given in parentheses. Panel A gives asset
pricing results using PIN estimates. Panel B gives asset pricing results using the PPIN proxy estimated
with the full set of economic variables given in Table 3. Panel C gives asset pricing results using the PPIN
proxy estimated with the restricted set of economic variables given in Table 7.

Panel A: PIN
Beta Size BM PIN Ret12

-0.190 0.104 0.248 1.679

(-0.80) (1.64) (2.94) (2.49)
-0.190 0.078 0.221 1.266 0.007
(-0.84) (1.25) (2.69) (2.03) (3.82)

Panel B: PPIN based on full set of explanatory variables

Beta Size BM PPIN Ret12

-0.251 0.246 0.255 8.626

(-1.01) (2.27) (3.14) (2.67)
-0.266 0.196 0.225 6.960 0.005
(-1.12) (1.85) (2.81) (2.21) (2.76)

Panel C: PPIN based on restricted set of explanatory variables

Beta Size BM PPIN Ret12

-0.228 0.296 0.250 12.061

(-0.92) (2.84) (3.09) (3.42)
-0.244 0.244 0.219 10.065 0.005
(-1.04) (2.37) (2.75) (2.91) (2.70)

43
 Table 9
PPINs and Asset Pricing

The table contains time series averages of the coefficients in cross-sectional asset pricing tests using the
standard Fama-MacBeth (1973) methodology for the extended sample period 1965-2004. The dependent
variable is the percentage monthly return. Betas are portfolio betas calculated from the full period using 40
portfolios. PPIN is the probability of information-based trading in stock i of year t-1 estimated from
accounting and market data. SIZE is the logarithm of market value of equity in firm i at the end of year t-1.
BM is the logarithm of the ratio of book value of common equity to market value of equity for firm i in
year t-1. RET12 is the return in month t-12 to t-1. Dvol is the dollar volume in month t-2 relative to the test
month. t-values are given in parentheses.

Specification Beta Size BM PPIN Ret12 Dvol

(1) -0.140 0.084

(-0.62) (5.00)
(2) -0.151 -0.120 0.229 0.404
(-0.82) (-2.97) (4.24) (2.60)
(3) 0.213 0.233 0.144 0.319
(2.01) (4.06) (3.68) (2.03)
(4) -0.128 -0.121 0.234
(-0.63) (-2.89) (4.21)
(5) 0.047 0.244 0.227 0.159
(0.28) (2.61) (4.11) (4.55)
(6) 0.023 0.221 0.227 0.147 0.294
(0.14) (2.52) (4.22) (4.43) (1.96)
(7) -0.115 0.207 0.067 0.390
(-0.58) (3.92) (4.13) (2.42)
(8) -0.125 0.250 0.542 -0.124
(-0.57) (4.16) (2.91) (-3.26)
(9) -0.049 0.171 0.228 0.217 0.119 0.167
(-0.31) (1.90) (4.24) (6.21) (0.82) (3.05)
(10) -0.135 -0.077 0.216 0.447 -0.050
(-0.82) (-1.04) (4.02) (2.89) (-0.93)
(11) -0.168 0.219 0.169 0.141 0.198
(-0.86) (4.18) (5.90) (0.92) (3.59)

44
 Table 10
Benchmark-adjusted returns to PPIN sorted portfolios

This table contains mean monthly percentage returns to PPIN portfolios for the extended sample period 1965-2004. PPIN is the probability of
information-based trading in stock i of year t-1 estimated from accounting and market data. Benchmark portfolios are constructed by sorting stocks into
deciles by the characteristic in question, where within each decile stocks are value weighted. Stock i is matched with one of the portfolio based on its
characteristic at time t-1, and the return of the matched portfolio is subtracted from stock i’s return at time t. Portfolios are rebalanced every month.
SIZE is the market value of equity in firm i at the end of year t-1. BM is the ratio of book value of common equity to market value of equity for firm i
in year t-1. RET12 is the return in month t-12 to t-1. DGTW benchmark portfolios are composed by ranking all stocks listed in CRSP based on their
market capitalization and assigning them to size quintiles using NYSE size quintile breakpoints. Within each size quintile, we further rank stocks based
on their book-to-market ratios, and assign them to book-to-market quintiles, yielding a total of 25 size- and book-to-market sorted portfolios. We
further sort stocks in each of 25 portfolios into quintiles, based on the prior 12-month return of each stock. DGTWI benchmark involves DGTW and
industry adjustments. Industry definitions are provided in Table 6.

NAME 1 2 3 4 5 6 7 8 9 10 10-1 t-stat

(10-1)

Raw 0.9174 1.1011 1.1460 1.1944 1.1962 1.2274 1.3497 1.4806 1.5993 2.3245 1.4071 4.841

MKT-adjusted 0.9095 1.0963 1.1414 1.1842 1.1866 1.2237 1.3411 1.4691 1.5930 2.3212 1.1411 5.273
SIZE-adjusted -0.0058 0.0904 0.0475 0.0728 0.0771 0.1119 0.2059 0.3014 0.2858 0.8726 0.9306 5.924
BM-adjusted -0.1137 0.0037 0.0348 0.0781 0.0563 0.0092 0.1165 0.2184 0.2788 0.8860 0.9995 7.376

Ret12-adjusted -0.0979 0.0739 0.1396 0.1961 0.2146 0.2157 0.3271 0.4696 0.5935 1.3026 1.4010 8.214
DGTW-adjusted -0.0722 0.0645 -0.0164 -0.0047 -0.0082 -0.0608 0.0114 0.0775 0.0896 0.6527 0.7249 4.956

DGTWI adjusted -0.0668 -0.0027 -0.0126 -0.0206 -0.0340 -0.1033 -0.0645 -0.0390 -0.0037 0.5518 0.6184 5.606
 Table 11
Average Returns to Information and Size sorted Portfolios

This table illustrates average percentage monthly returns on equally weighted portfolios balanced monthly by size
and information effects. In Panel A, information effects captured by PPIN for the extended sample period 1965-
2004. In Panels B and C, information is proxied by PIN and PPIN for the sample period 1983-199, respectively.
In the column labeled ‘Size Quintiles’, each month we first sort stocks into five quintiles on the basis of size,
where 5 is the largest firms. Then, within each size quintile, we sort stocks into five portfolios sorted by PPINs
(1965-2004). The row (column) “Mean” gives average monthly returns controlling for size (PPIN). The column
’5-1’ refers to the difference in monthly returns between portfolio 5 and portfolio 1.

Panel A. PPIN (1965-2004) quintiles

Size quintiles 1 2 3 4 5 Mean 5-1 (t-stat)
1 1.05 1.52 1.60 2.16 2.87 1.84 1.82 (5.42)

2 0.83 1.20 1.55 1.59 1.63 1.36 0.80 (4.63)

3 1.03 1.18 1.37 1.45 1.57 1.32 0.54 (4.87)

4 1.04 1.21 1.19 1.30 1.31 1.21 0.27 (4.93)

5 0.90 1.00 1.01 1.16 1.15 1.04 0.25 (4.70)

Panel B. PPIN (1983-1999) quintiles

Size quintiles 1 2 3 4 5 Mean 5-1 (t-stat)
1 0.24 0.83 0.91 1.57 1.99 1.11 1.75 (2.65)

2 0.42 0.82 1.04 1.08 1.02 0.88 0.60 (2.51)

3 0.89 0.83 1.04 1.15 1.14 1.01 0.25 (2.91)

4 1.17 1.07 1.14 1.17 1.30 1.17 0.13 (3.59)

5 1.38 1.19 1.22 1.27 1.28 1.27 -0.10 (4.32)

Panel C. PIN (1983-1999) quintiles

Size quintiles 1 2 3 4 5 Mean 5-1 (t-stat)
1 0.65 0.81 0.78 1.09 1.77 1.02 1.12 (2.33)

2 0.66 0.96 0.67 0.84 1.00 0.82 0.34 (2.32)

3 1.01 1.03 1.02 1.10 1.05 1.04 0.04 (2.99)

4 1.17 1.19 1.28 1.18 1.11 1.19 -0.06 (3.60)

5 1.37 1.37 1.25 1.42 1.30 1.34 -0.07 (4.35)

 Table 12
Fama-MacBeth (1973) regression coefficients averaged across size quintiles

This table provides Fama-MacBeth (1973) parameter estimates averaged across size quintiles and
across time. PPIN is the probability of information-based trading in stock i of year t-1 estimated
from accounting and market data for the extended sample period 1965-2004. PIN is the probability
of information-based trading in stock i of year t-1 estimated from trade data. Betas are portfolio
betas calculated from the full period using 40 portfolios. SIZE is the logarithm of market value of
equity in firm i at the end of year t-1. BM is the logarithm of the ratio of book value of common
equity to market value of equity for firm i in year t-1.

PPIN (1965-2004) PPIN (1983-1999) PIN (1983-1999)

Parameter t-value Parameter t-value Parameter t-value

Estimate Estimate Estimate

Intercept -1.630 -4.87 -0.947 -2.06 1.037 5.95

Beta 0.015 0.15 -0.178 -1.19 -0.102 -0.75
BM 0.194 5.34 0.202 3.96 0.236 4.58
PPIN 0.126 8.95 9.453 5.02 0.645 2.33
Figure 1. Tree Diagram of the Trading Process. α is the probability of an information event, δ is the probability of a low signal, µ
is the rate of informed trade arrival, εb is the arrival rate of uninformed buy orders and εs is the arrival rate of uninformed sell orders.
Nodes to the left of the dotted line occur once per day.
Buy Arrival Rate: εb
Signal Low δ

Sell Arrival Rate: εs + µ

Information Event Occurs α

Buy Arrival Rate: εb + µ

Signal High (1−δ)

Sell Arrival Rate: εs

Buy Arrival Rate: εb

Information Event Does Not Occur (1−α)

Once per Day Sell Arrival Rate: εs
 Number of stocks Number of stocks

0. 0.

0
500
1000
1500
2000
2500
0
500
1000
1500
2000
2500
00 00
0. 0.
05 05
0. 0.
10 10
0. 0.
15 15
0. 0.
20 20
0. 0.
25 25
0. 0.
30 30
0. 0.
35 35
0. 0.
40 40

Figure 2: Distribution of PIN and PPIN

0. 0.
45 45
0. 0.
50 50

PIN
0. 0.

PPIN
55 55
0. 0.
60 60
0. 0.
65 65
0. 0.
70 70
0. 0.
75 75
0. 0.
80 80
0. 0.
85 85
0. 0.
90 90
0. 0.
95 95
 35

30

25
PPIN, in percent

p5
20
p25
p50
15 p75
p95
10

0
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
Year

Figure 3: Distribution of PPIN across extended sample period

The figure shows the cross-sectional distribution of the proxy estimating probability of
information based trading, PPIN. The figure shows the 5th, 25th, 50th, 75th and 95th
percentiles each year in the sample period for the cross-sectional distribution of PPIN.

50
Figure 4: Annual Fama-Macbeth (1973) Coefficients

51