Information-Based Accruals Strategy

This paper hypothesizes that more active informed trading and intense information production help investors detect the low persistence of accruals, and consequently reduce the magnitude of accruals mis-pricing. Applying both the Mishkin (1983) and the hedge-portfolio tests to sub-samples sorted on the basis of a two-way classification-one for accruals, and one of the information production measures-we find evidence showing that accruals mis-pricing is more conspicuous for stocks with high bid-ask spread, high analysts' forecast error, and low presence of sophisticated institutional investors. Accruals trading strategies restricted to stocks where information production has been less intense and effective can yield annualized four-factor adjusted abnormal returns (the Fama-French three factors and the momentum factor) ranging from 14% to 23%. We also find that the market does not overreact to normal accruals for firms where information production is intense and effective.