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Trading Volume: Implications of An Intertemporal Capital Asset Pricing Model

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  • Andrew W. Lo
  • Jiang Wang

Abstract

We derive an intertemporal capital asset pricing model with multiple assets and heterogeneous investors, and explore its implications for the behavior of trading volume and asset returns. Assets contain two types of risks: market risk and the risk of changing market conditions. We show that investors trade only in two portfolios: the market portfolio, and a hedging portfolio, which allows them to hedge the dynamic risk. This implies that trading volume of individual assets exhibit a two-factor structure, and their factor loadings depend on their weights in the hedging portfolio. This allows us to empirically identify the hedging portfolio using volume data. We then test the two properties of the hedging portfolio: its return provides the best predictor of future market returns and its return together with the return of the market portfolio are the two risk factors determining the cross-section of asset returns.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8565.

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Date of creation: Oct 2001
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Publication status: published as Andrew W. Lo & Jiang Wang, 2006. "Trading Volume: Implications of an Intertemporal Capital Asset Pricing Model," Journal of Finance, American Finance Association, vol. 61(6), pages 2805-2840, December.
Handle: RePEc:nbr:nberwo:8565

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Citations

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Cited by:
  1. Bruno Biais & Peter Bossaerts & Chester Spatt, 2003. "Equilibrium Asset Pricing Under Heterogeneous Information," Levine's Bibliography 666156000000000086, UCLA Department of Economics.
  2. Malcolm Baker & Jeremy C. Stein, 2002. "Market Liquidity as a Sentiment Indicator," Harvard Institute of Economic Research Working Papers 1977, Harvard - Institute of Economic Research.
  3. Martijn Cremers & Jianping Mei, 2004. "Turning Over Turnover," Yale School of Management Working Papers ysm429, Yale School of Management, revised 01 May 2008.
  4. Omid Sabbaghi & Navid Sabbaghi, 2014. "An empirical analysis of the Carbon Financial Instrument," Journal of Economics and Finance, Springer, vol. 38(2), pages 209-234, April.
  5. Amir E. Khandani & Andrew W. Lo, 2008. "What Happened To The Quants In August 2007?: Evidence from Factors and Transactions Data," NBER Working Papers 14465, National Bureau of Economic Research, Inc.
  6. Chang, Eric C. & Cheng, Joseph W. & Pinegar, J. Michael, 2008. "The factor structure of time-varying conditional volume," Journal of Empirical Finance, Elsevier, vol. 15(2), pages 251-264, March.
  7. Steven L. Heston & Robert A. Korajczyk & Ronnie Sadka, 2010. "Intraday Patterns in the Cross-section of Stock Returns," Papers 1005.3535, arXiv.org.
  8. Orhan Erdem & Evren Arik & Serkan Yüksel, 2013. "Trading Puzzle, Puzzling Trade," Working Paper 05, Research and Business Development Department, Borsa Istanbul.
  9. Maio, Paulo & Santa-Clara, Pedro, 2012. "Multifactor models and their consistency with the ICAPM," Journal of Financial Economics, Elsevier, vol. 106(3), pages 586-613.
  10. Pascal St-Amour, 2005. "Direct Preference Wealth in Aggregate Household Portfolios," FAME Research Paper Series rp136, International Center for Financial Asset Management and Engineering.
  11. Gaiyan Zhang, 2007. "A Model of Price, Volume, and Sequential Information," International Journal of Business and Economics, College of Business, and College of Finance, Feng Chia University, Taichung, Taiwan, vol. 6(3), pages 207-223, December.
  12. Ricardo M. Sousa, 2007. "Wealth Shocks and Risk Aversion," NIPE Working Papers 28/2007, NIPE - Universidade do Minho.
  13. Pascal St-Amour, 2005. "Direct Preference for Wealth in Aggregate Household Portfolio," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 05.04, Université de Lausanne, Faculté des HEC, DEEP.
  14. Hiroshi Konno & Yuuhei Morita & Rei Yamamoto, 2010. "A maximal predictability portfolio using absolute deviation reformulation," Computational Management Science, Springer, vol. 7(1), pages 47-60, January.
  15. Zhong-Guo Zhou, 2010. "The high-volume return premium: evidence from the Chinese stock market," Review of Quantitative Finance and Accounting, Springer, vol. 35(3), pages 295-313, October.

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