Does information risk affect the implied cost of equity capital? An analysis of PIN and adjusted PIN

Highlights • Prior studies document that trade specification using the Lee and Ready (1991) algorithm is far from accurate. • Using a unique dataset of Korean listed companies for which trade initiators are correctly identifiable, we reexamine whether PIN affects stock investors' expected rate of returns. • We find that the bias-free adjusted PIN, purged of a liquidity component, is significantly and positively related to implied costs of equity (ICOE). • Our findings suggest that the errors in PIN variables hamper a proper identification of PIN pricing in prior studies. Abstract Using a unique dataset of Korean listed companies for which trade initiators are correctly identifiable, we estimate bias-free PIN (probability of informed trading) that is no longer subject to the trade misspecification problem and test whether it is related to expected returns. Unlike prior studies, we find that bias-free AdjPIN, the adjusted PIN purged of a liquidity component, is positively related to implied cost of equity. Our findings suggest that the errors in PIN variables hamper a proper identification of PIN pricing in prior studies.

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Journal of Accounting & Economics

The Journal of Accounting and Economics is a peer-reviewed academic journal focusing on the fields of accounting and economics.

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