An Epidemiological Approach to Opinion and Price-Volume Dynamics
Singapore Management University - Lee Kong Chian School of Business
Harrison G. Hong
Princeton University - Department of Economics; National Bureau of Economic Research (NBER)
January 3, 2011
AFA 2012 Chicago Meetings Paper
We develop a simple and tractable model of opinions and price-volume dynamics based on a word-of-mouth communication process widely used in epidemiology. Risk-averse investors have different opinions depending on whether they heard the news from a friend. Opinions initially diverge and then converge over time as news spreads, which leads to price adjustment and trading volume. News released to many leads to an expected difusion rate (the change in the fraction of investors with the news) that declines with time. But news initially released to few leads to an expected diffusion rate that initially increases in time and only then decreases. The serial correlation of stock returns and trading volume are proportional to the diffusion rate. The term structure of the serial correlation of non-overlapping returns can be declining or hump-shaped in time depending on whether the news was widely released. We test and verify these predictions and show that this model is useful for understanding news and price momentum and the dynamics of investor and analyst expectations around media events.
Number of Pages in PDF File: 50
Keywords: Word of Mouth, Information Diffusion, Public News, Private News
JEL Classification: G10, G12, G14
Date posted: March 13, 2010 ; Last revised: November 13, 2013
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