| Essay 1. Is underreaction related to behavioral biases? Studies show that stock prices underreact to news over a period of up to 12 months. The source of underreaction, however, remains controversial. We present empirical evidence that suggests such underreaction may be related to institutional investors' behavioral biases. Using a sample of trading data on 13F institutional investors from the second quarter of 1978 to the first quarter of 2001, we find that institutional investors who held the stock longer sold the shares later and those who held the stock shorter sold the shares earlier. Such a positive length relation (PLR) is significant in the sample period during which stocks experienced negative returns for four consecutive quarters, but with less or no significance in the six quarters before and after the sample period. There is evidence that the PLR is significantly related to two behavioral biases—conservatism and representativeness.;Essay 2. The relation between the asset liquidity and the trading liquidity: An empirical investigation. Using a sample of public firms from 1994 to 1998, we examine the relation between the firms' asset liquidity and their stocks' trading liquidity. The results show that the higher the firms' asset liquidity, the lower their stocks' trading liquidity. This relation does not hold for banks. Bank stocks have lower trading liquidity than other firms' stocks do. The results are consistent with market microstructure theory and support the paradox of asset liquidity suggested by recent theory. The results may suggest that firms with severe asset substitution and entrenching investment problems may have a different trading behavior of their stocks than those of others. |
