Long-term Information, Short-lived Securities
AbstractWe explore strategic trade in short-lived securities by agents who possess long-term information. Trading short-lived securities is profitable only if enough of the private information becomes public prior to contract expiration; otherwise the security will worthlessly expire. We highlight how this results in trading behavior fundamentally different from that observed in standard models of informed trading in equity. Specifically, we show that informed agents are more reluctant to trade shorter-term securities too far in advance of when their information will necessarily be made public, and that existing positions in a shorter-term security make future purchases more attractive. Because informed agents prefer longer-term securities, this can make trading shorter-term contracts more attractive for liquidity traders. We characterize the conditions under which liquidity traders choose to incur extra costs to roll over short-term positions rather than trade in distant contracts, providing an explanation for why most longer-term derivative security markets have little liquidity and large bid-ask spreads.
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Bibliographic InfoPaper provided by Henley Business School, Reading University in its series ICMA Centre Discussion Papers in Finance with number icma-dp2003-10.
Length: 42 pages
Date of creation: Jul 2003
Date of revision:
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Priviate information; derivative securities; rolling the hedge; fixed transaction costs;
Find related papers by JEL classification:
- G1 - Financial Economics - - General Financial Markets
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
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