Quantifying Investor Distraction

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Recent research in the field of behavioral finance has focused on investor inattention or distraction respectively. The rationale behind this is that investors also face attention constraints and might, therefore, be overburdened by lots of competing news. Studies have shown that investors underreact to earnings announcements when there is a greater number of same-day earnings announcements by other firms (see e.g. Hirshleifer et al., 2009; Moulton & Leow, 2014). However, it may also be worth investigating whether investors underreact to news when there is more potential distraction by other (more general) news. On that note, I would like to present the idea of defining a broad market news index based on EDGAR filings in this blog post.

In recent posts on our blog, the EDGAR database has already been introduced. As outlined before, US publicly-listed firms are obliged to file a variety of reports on the SEC‘s EDGAR database in a timely manner in order to inform investors about the firm‘s current financial performance and other important events, which might affect the firm‘s valuation. For instance, these filings include annual and quarterly reports, reports about changes in the management team, changes in the ownership structure, dividend announcements, etc. For a more detailed overview, go to https://www.sec.gov/info/edgar/forms/edgform.pdf

Kindly, for each year since 1993, the SEC provides free access to data about all the filings that were issued by US publicly-listed companies on each trading day. As the idea of our market news index is to provide a measure of all the different company news on a trading day, we aggregate all the filings issued by all companies per day. This allows us to investigate how much news and, therefore, potential distraction arrived on the capital market on a particular trading day. To account for skewness in the data, we use the natural logarithm to transform the data. Considering this, the market news index for a single trading day can be defined as shown in the following equation :


where i stands for an individual company filing reports on EDGAR and t for a trading day.

Our market news index can also be calculated to account for the amount of news that investors have to deal with surrounding a certain event. To do so, we cumulate the filings that were issued on the days surrounding the event and again apply the natural logarithm. This might be of interest when conducting event studies. For instance, one potential application might include investigating whether investors underreact to changes in the management team when they are distracted by lots of competing news surrounding the event.

In a follow-up post, we will also present the idea of applying a filter on certain filing types, which might have a more direct effect on a firm‘s valuation. Investors who face attention constraints might put more focus on those filings and neglect filings which they expect to be less relevant. Be sure to follow this blog for more information.

References:

Hirshleifer, D., Lim, S. S., & Teoh, S. H. (2009). Driven to Distraction: Extraneous Events and Underreaction to Earnings News. The Journal of Finance, 64(5), 2289–2325. doi: 10.1111/j.1540-6261.2009.01501.x

Moulton, P. C., & Leow, S. (2014). Earnings Announcements and Investor Focus in the Hospitality Industry. Cornell Hospitality Quarterly, 56(1), 5–16. doi: 10.1177/1938965513516826

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