Informed Trading and Portfolio Returns
HSE Moscow; University of Houston - C.T. Bauer College of Business
University of California, Berkeley - Haas School of Business
University of California, Berkeley
January 11, 2010
We solve a multi-period model of strategic trading with long-lived information in multiple assets with correlated innovations in fundamental values. Market makers in each asset can only condition their price functions on trading in the that asset (but not on trading in the other asset). Using daily non-public data from the New York Stock Exchange we test the model's predictions on the conditional and unconditional lead-lag relations of institutional order flows and returns within portfolios. We find support for the model prediction of positive autocorrelations in portfolio returns as well as the predictions for how informed order flow positively predicts future returns and future informed order flow. As the model predicts we find these relations strengthen for portfolios formed from assets with higher correlation of fundamental values.
Number of Pages in PDF File: 42
Keywords: informed trading, portfolio autocorrelations, adverse selection
Date posted: September 11, 2009 ; Last revised: January 14, 2010
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