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Trading on Short-Term Information

  • Alexander Gumbel

    ()

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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File URL: http://www.finance.ox.ac.uk/file_links/finecon_papers/1999fe10.pdf
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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
Contact details of provider: Web page: http://www.finance.ox.ac.uk
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  1. Heinkel, Robert & Stoughton, Neal M, 1994. "The Dynamics of Portfolio Management Contracts," Review of Financial Studies, Society for Financial Studies, vol. 7(2), pages 351-87.
  2. Judith A. Chevalier & Glenn D. Ellison, 1995. "Risk Taking by Mutual Funds as a Response to Incentives," NBER Working Papers 5234, National Bureau of Economic Research, Inc.
  3. Jeremy C. Stein, 1989. "Efficient Capital Markets, Inefficient Firms: A Model of Myopic Corporate Behavior," The Quarterly Journal of Economics, Oxford University Press, vol. 104(4), pages 655-669.
  4. Bhattacharya, Sudipto & Pfleiderer, Paul, 1985. "Delegated portfolio management," Journal of Economic Theory, Elsevier, vol. 36(1), pages 1-25, June.
  5. Istemi Demirag, 1995. "Short-term performance pressures: is there a consensus view?," The European Journal of Finance, Taylor & Francis Journals, vol. 1(1), pages 41-56.
  6. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  7. James Dow & Gary Gorton, 1993. "Arbitrage Chains," NBER Working Papers 4314, National Bureau of Economic Research, Inc.
  8. Shleifer, Andrei & Vishny, Robert W, 1990. "Equilibrium Short Horizons of Investors and Firms," American Economic Review, American Economic Association, vol. 80(2), pages 148-53, May.
  9. Dasgupta, Amil & Prat, Andrea, 2003. "Trading Volume with Career Concerns," CEPR Discussion Papers 4034, C.E.P.R. Discussion Papers.
  10. Spiegel, Matthew & Subrahmanyam, Avanidhar, 1992. "Informed Speculation and Hedging in a Noncompetitive Securities Market," Review of Financial Studies, Society for Financial Studies, vol. 5(2), pages 307-29.
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