Review of Accounting Studies, 5, 127–153 (2000)
2000 Kluwer Academic Publishers, Boston. Manufactured in The Netherlands.
Information Asymmetry, Investment Horizons, and
the Dual Role of Public Announcements
London Business School, Sussex Place, Regent’s Park, London NW1 4SA, United Kingdom
Abstract. This paper investigates inter-temporal relations in market liquidity and price efﬁciency in a setting
that is more descriptive of trading patterns around public announcements than those typically analyzed in the
existing literature. The model incorporates both strategic investors who behave as short-term, proﬁt-taking traders,
and traders who invest in the security over a long-term horizon. It is shown that an anticipated increase in
market liquidity in the announcement period will lead short-term investors to trade more aggressively in the pre-
announcement period. This results in improved price efﬁciency and, in some cases, increased market liquidity
in the pre-announcement period. However, a higher propensity to behave as a proﬁt-taker in the announcement
period leads to less efﬁcient prices in the pre-announcement period.
Keywords: Public announcements, investment horizons, price efﬁciency, market liquidity, trading volume
The purpose of this paper is to investigate the inter-temporal relations in market liquidity
and price efﬁciency around public announcements in a setting that is more descriptive
of trading patterns around such announcements than those typically analyzed in existing
literature. I study a model in which public announcements play a dual role in that they
simultaneously eliminate pre-announcement information asymmetry and stimulate new
information asymmetry in the marketplace. While there is a signiﬁcant body of research
that looks at the effects of public announcements on market behavior, a common thread
is that such announcements either reduce pre-announcement information asymmetry or
generate information asymmetry in the announcement period, but not both. In addition, the
literature has typically assumed that informed investors have identical investment horizons.
I relax this assumption by suggesting that public announcements may prompt investors with
different investment horizons to interact in the marketplace.
The analysis centers on two main themes. The ﬁrst concerns factors affecting market
liquidity around announcement periods, as well as the relation between market liquidity in
the pre-announcement period and market liquidity in the announcement period. As market
liquidity is of great interest to practitioners, regulators and academics, the analysis of this
theme contributes to our understanding of the factors that inﬂuence this important feature
of capital markets around the time of mandated public announcements.
The second theme
concerns the effect of anticipated new information asymmetry in the announcement period
on the price discovery process, or price efﬁciency, in the pre-announcement period. A
positive link between market liquidity in the announcement period and price efﬁciency in
the pre-announcement period is established and investigated.