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Trading Volume: Implications of An Intertemporal Capital Asset Pricing Model

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Andrew W. Lo
Jiang Wang

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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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Handle: RePEc:nbr:nberwo:8565

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Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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  1. Malcolm Baker & Jeremy C. Stein, 2002. "Market Liquidity as a Sentiment Indicator," NBER Working Papers 8816, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  2. 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. [Downloadable!]
  3. Bruno Biais & Peter Bossaerts & Chester Spatt, 2003. "Equilibrium Asset Pricing Under Heterogeneous Information," Levine's Bibliography 666156000000000086, UCLA Department of Economics. [Downloadable!]
    Other versions:
  4. Ricardo M. Sousa, 2007. "Wealth Shocks and Risk Aversion," NIPE Working Papers 28/2007, NIPE - Universidade do Minho. [Downloadable!]
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