Is Good News Really Bad News? Event Study With Correlated Market And Non-Market Signals In An Asset Pricing Model
Speaker(s) Dr. Murugappa (Murgie) Krishnan, Professor, Rutgers University and Radford University. Publication CAFRAL Conference room on Mezzanine Floor, Main Building. Reserve Bank of India, Fort, Mumbai 400 001

How informed are Foreign Institutional Investors (FIIs) in Indian financial markets? We build a model of imperfect competition in a financial market, in which market makers have up to two public signals on which to define their pricing rule – firms’ earnings announcements and FII trading signals. We define the payoff structure with a sum of correlated components, one known to firms, and the other, to FIIs. We estimate the deep parameters of the model such as the variance governing the FIIs’ informational advantage, the level of background noise, and the correlation between the two components of the payoff. So instead of treating multicollinearity as a problem to be resolved using more orthogonal instruments, or a better selection of regressors, we explain it using an underlying model of financial market equilibrium, and identify deep parameters that are unobservable but have economic significance.


Our results indicate the information advantage of FIIs with respect to the component they have information about, exceeds the information advantage that firms have with respect to information released via earnings announcements. We also find that correlation between the two fundamental information components is significantly positive, so that in econometric work we should consider such an environment, even beyond any correlation arising from imperfect measurement. A methodological contribution is to show how the underlying model of equilibrium allows us to learn more from the event study based on earnings announcements.

Download Paper