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Trading Volume: Implications of An Intertemporal Capital Asset Pricing Model

  • Andrew W. Lo
  • Jiang Wang

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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File URL: http://www.nber.org/papers/w8565.pdf
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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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Publication status: published as Andrew W. Lo & Jiang Wang, 2006. "Trading Volume: Implications of an Intertemporal Capital Asset Pricing Model," Journal of Finance, American Finance Association, vol. 61(6), pages 2805-2840, December.
Handle: RePEc:nbr:nberwo:8565
Note: AP
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