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Trading on Short-Term Information

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  • Alexander Gumbel

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Abstract

In this paper we address the question as to why fund managers may trade on short-term information in a financial market that offers more profitable trading on long-term information. We consider a setting in which a fund manager’s ability is unknown and an investor uses performance observations to learn about this ability. We show that an investor learns less efficiently about the ability of a fund manager when he trades on long-term information compared to trading on short-term information. This is the case, because the information on which a manager bases his trades is less precise the longer the information horizon, and thus performance observations contain more noise. Moreover, under trading on long-term information, performance observations become available after a short period only if the manager unwinds his position early. Such performance observations, however, are generally contaminated with additional noise, because unwinding prices only reveal underlying asset value imperfectly. When the informational efficiency of short-term prices increases, this effect becomes less pronounced, because a long-term trader who unwinds his position after a short time can convey an increasing amount of information concerning his ability to the investor. At the same time, trading on short-term information becomes less profitable, and therefore the investor’s incentive to induce short-term trading weakened. Nevertheless, we show that short-term trading may be induced even when prices fully reveal short-term information.

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Bibliographic Info

Paper provided by Oxford Financial Research Centre in its series OFRC Working Papers Series with number 1999fe10.

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Date of creation: 1999
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Handle: RePEc:sbs:wpsefe:1999fe10

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Web page: http://www.finance.ox.ac.uk
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Cited by:
  1. John Thanassoulis, 2011. "Industrial Structure, Executives' Pay And Myopic Risk Taking," Economics Series Working Papers 571, University of Oxford, Department of Economics.
  2. Casamatta, Catherine & Pouget, Sébastien, 2009. "Fund Managers' Contracts and Financial Markets' Short-Termism," IDEI Working Papers 553, Institut d'Économie Industrielle (IDEI), Toulouse, revised Feb 2011.
  3. Casamatta, Catherine & Pouget, Sébastien, 2009. "Fund Managers' Contracts and Short-Termism," TSE Working Papers 09-042, Toulouse School of Economics (TSE).

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