The authors explore whether cross-country cultural differences explain the information content of stock markets around the world. They argue that behavioral biases are signals of different risk preferences that affect how investors respond to firm-specific information. The information content of stock markets seems to be higher in countries with investors who are more individualistic and less likely to avoid uncertainty. For example, there is lower explanatory power of the market model, higher return volatility, and higher trading volume in these countries.

The authors conclude that differences in the behavior of local investors can affect how information is incorporated into stock prices in that country and how this effect differs by country. In particular, high individualism is associated with overconfidence, self-attribution biases, and a strong preference for risk, whereas less uncertainty avoidance is associated with less conservative and less risk-averse behavior. The results indicate that more individualistic investors overreact to firm-specific information and trade excessively. It would be prudent for practitioners to use these results to guide their investment decisions in international markets.

The authors admit that their study leaves several issues unaddressed. First, as cross-border investments become more popular, the impact of the behavioral biases and risk preferences of investors may not be captured by the country-specific cultural indices the authors use. Second, such sophisticated investors as institutional investors and wealthy individuals who invest across many countries may lessen the behavioral biases in markets in which they invest. Third, one alternative explanation for the results is that the information content of earnings and synchronicity are not manifested in firm-specific information but, instead, in the types of economic activity different cultures are willing to engage in.

The data are 151,394 annual earnings announcements from 42 countries over the period of 1990–2006. The authors use one long-term proxy and two short-term proxies for the information content of stock markets. For the long-term proxy, they use the R² from an augmented market model regression over a 240-day period preceding annual earnings announcements using I/B/E/S data. The model uses a market proxy and lags and leads of the local market return as independent variables. The lag and lead variables are used to reduce the possible effect of infrequent trading in less liquid markets.

They then measure country stock price synchronicity, which is a measure of the extent that firm-specific information is incorporated into stock prices in the long term as an equally weighted R² across all firms in a particular country for each year that country appears in the sample.

For the two short-term proxies, the authors use abnormal return variance and abnormal trading volume around earnings announcement dates. Stock price synchronicity, abnormal return variance, and abnormal trading volume are used as the dependent variables in the regressions.

For the independent variables in these regressions, the authors use individualism and uncertainty avoidance indices that are based on a cross-country psychological survey. This survey was first conducted in 1980 and was extended across 74 countries in 2001. To better isolate the effects of individualism and uncertainty avoidance, the authors add the following control variables, which are often considered to be related to the information content in stock markets: developed versus emerging markets, shareholder protection, accounting standards, good governance, and insider-trading enforcement.

The authors shed new light on how varying investor behavior across countries affects the rate at which information gets incorporated into the prices of each country’s stocks. But they admit that these results do not consider cross-border and/or sophisticated investor investments. Because the behavior of foreign individuals and institutions differs from that of local investors, it is unclear how controlling for cross-border and/or sophisticated investor investments would change the results.