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Fundamental volatility and informative trading volume in a rational expectations equilibrium

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  • Luo, Dan
  • Mao, Yipeng

Abstract

This paper presents a tractable model of asset price with informative trading volume. Investors condition demands on their rational expectations of both the equilibrium price and trading volume. We suggest a new information role of trading volume, which enables the investors to extract continuous information regarding the liquidation value volatility of the risky asset. The liquidation value volatility determines the relative importance of fundamental value and noise trading in the price function. It also monotonically increases the price volatility. We provide an explanation of the negative and nonlinear relationship between price volatility and trading volume. We also examine the effects of information accuracy and investor composition on the equilibrium price distribution and trading volume.

Suggested Citation

  • Luo, Dan & Mao, Yipeng, 2021. "Fundamental volatility and informative trading volume in a rational expectations equilibrium," Economic Modelling, Elsevier, vol. 105(C).
    • Handle: RePEc:eee:ecmode:v:105:y:2021:i:c:s0264999321002522
    DOI: 10.1016/j.econmod.2021.105663
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    More about this item

    Keywords

    Fundamental volatility; Trading volume; Rational expectations equilibrium; Price distribution; Information accuracy;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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