Extra! Extra! Nothing Happens—and Investors Profit

A lack of terrorist incidents bodes well for a government’s antiterrorism efforts. No layoff or bankruptcy announcements during a downturn may indicate a firm’s strength. Often these non-news events go unnoticed, but they contain valuable information markets tend to overlook—and that results in price distortions from which savvy investors can benefit.

The data-intensive financial markets provide fertile ground to test this theory. Stefano Giglio and Kelly Shue, assistant professors at Chicago Booth, examine the information content of no news by focusing on corporate mergers, which provide well-defined starting and ending points for the analysis. After a merger is announced, the passage of time may contain information about the probability that the merger will be completed or fail.

Investors tend not to recognize that the absence of news also contains valuable information, even though it isn’t marked by traditional, attention-grabbing news stories, the research shows. As a result, “boundedly rational investors,” defined as individual investors with more limited resources, tend to give the passage of time less attention than is appropriate when making decisions, and that can impact merging companies’ stock prices and investors’ returns.

The researchers empirically back their conclusion by examining more than 5,000 mergers between 1970 and 2010. They calculate the “hazard rate” of merger completion, or the likelihood a merger will be completed by a certain time, assuming it hasn’t already been completed or been called off, and find the hazard rate forms a consistent “hump shape” across the mergers.

After a merger is announced, it becomes increasingly likely that a deal will be completed, but as time passes, the probability of completion drops drastically. The likelihood of completion rises from zero prior to the merger’s announcement, peaks in week 25, and declines to zero within a year. The hump pattern holds steady despite the various sizes of companies involved and the variety of financing used.

Key to the research findings: weekly returns on merger investment strategies can be predicted by looking at the average probability, in each week, that a merger will be completed. In weeks in which the probability of completion is high, typically 15–30 weeks after the announcement of a deal, average returns are also high. Therefore, investors can profit by investing during these weeks.

The researchers show that the higher returns do not come with higher risk. This indicates that some behavioral phenomenon must be at work, and would explain why investors leave money on the table. Giglio and Shue conclude that investors, by ignoring the information contained in the passage of time, may be initially underestimating the probability that a merger will be completed and then overestimating the probability later.

The researchers also present evidence that the mispricing is stronger for deals that involve less liquid stocks and higher transaction costs. Even sophisticated investors in those types of deals who recognize the information value in time passing are often unable to arbitrage away the mispricing.

If most market participants are overlooking a valuable piece of information that fails to make headlines, other, more sophisticated investors can incorporate it into their models to derive a more efficient price, and potentially profit.