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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.

Suggested Citation

  • Andrew W. Lo & Jiang Wang, 2001. "Trading Volume: Implications of An Intertemporal Capital Asset Pricing Model," NBER Working Papers 8565, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:8565
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    Cited by:

    1. Khandani, Amir E. & Lo, Andrew W., 2011. "What happened to the quants in August 2007? Evidence from factors and transactions data," Journal of Financial Markets, Elsevier, vol. 14(1), pages 1-46, February.
    2. Serge Darolles & Gaëlle Le Fol, 2003. "Trading Volume and Arbitrage," Working Papers 2003-46, Center for Research in Economics and Statistics.
    3. John Cotter & Enrique Salvador, 2014. "The non-linear trade-off between return and risk: a regime-switching multi-factor framework," Papers 1410.6005, arXiv.org.
    4. repec:eee:ecmode:v:69:y:2018:i:c:p:26-37 is not listed on IDEAS
    5. Bruno Biais & Peter Bossaerts & Chester Spatt, "undated". "Equilibrium Asset Pricing Under Heterogeneous Information," GSIA Working Papers 2003-E42, Carnegie Mellon University, Tepper School of Business.
    6. Baker, Malcolm & Stein, Jeremy C., 2004. "Market liquidity as a sentiment indicator," Journal of Financial Markets, Elsevier, vol. 7(3), pages 271-299, June.
    7. Orhan ERDEM & Evren ARIK & Serkan YÜKSEL, 2014. "Trading Puzzle, Puzzling Trade," Iktisat Isletme ve Finans, Bilgesel Yayincilik, vol. 29(345), pages 83-102.
    8. K. J. Martijn Cremers & Jianping Mei, 2007. "Turning over Turnover," Review of Financial Studies, Society for Financial Studies, vol. 20(6), pages 1749-1782, November.
    9. Pascal St-Amour, 2005. "Direct Preference Wealth in Aggregate Household Portfolios," FAME Research Paper Series rp136, International Center for Financial Asset Management and Engineering.
    10. 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.
    11. Villena, Marcelo J. & Reus, Lorenzo, 2016. "On the strategic behavior of large investors: A mean-variance portfolio approach," European Journal of Operational Research, Elsevier, vol. 254(2), pages 679-688.
    12. Steven L. Heston & Robert A. Korajczyk & Ronnie Sadka, 2010. "Intraday Patterns in the Cross-section of Stock Returns," Journal of Finance, American Finance Association, vol. 65(4), pages 1369-1407, August.
    13. Ricardo M. Sousa, 2007. "Wealth Shocks and Risk Aversion," NIPE Working Papers 28/2007, NIPE - Universidade do Minho.
    14. Zhaodan Huang & James B. Heian, 2010. "Trading-Volume Shocks And Stock Returns: An Empirical Analysis," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 33(2), pages 153-177.
    15. 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.
    16. Omid Sabbaghi & Navid Sabbaghi, 2014. "An empirical analysis of the Carbon Financial Instrument," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 38(2), pages 209-234, April.
    17. Boyce Watkins, 2007. "The economic and predictive value of trading volume growth: a tale of three moments," Applied Financial Economics, Taylor & Francis Journals, vol. 17(18), pages 1489-1509.
    18. 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.
    19. Mila Getmansky & Peter A. Lee & Andrew W. Lo, 2015. "Hedge Funds: A Dynamic Industry In Transition," NBER Working Papers 21449, National Bureau of Economic Research, Inc.
    20. Robert Elliott & Tak Siu, 2015. "Asset Pricing Using Trading Volumes in a Hidden Regime-Switching Environment," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 22(2), pages 133-149, May.
    21. 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.
    22. 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.
    23. 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.
    24. Boyce Watkins, 2006. "Do emerging markets with consistent returns have better future performance?," Quantitative Finance, Taylor & Francis Journals, vol. 6(5), pages 411-422.

    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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