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Risk Sharing, Costly Participation, and Monthly ReturnsTerrence HendershottUniversity of California, Berkeley - Haas School of Business Sunny X. LIVU University Amsterdam; Tinbergen Institute - Tinbergen Institute Amsterdam (TIA) Albert J. MenkveldVU University Amsterdam; Tinbergen Institute - Tinbergen Institute Amsterdam (TIA); Duisenberg School of Finance Mark S. SeasholesHong Kong University of Science & Technology (HKUST) December 10, 2010 23rd Australasian Finance and Banking Conference 2010 Paper Midwest Finance Association 2012 Annual Meetings Paper Abstract: This paper studies the joint dynamics of stock price movements and the trading of individuals, institutions, and market makers. We propose a multi-period model in which agents have different risk sharing motives and participation costs. A state-space model and proprietary NYSE trading data are used to test predictions regarding returns, order flows, and return-flow dynamics. The results show that 25% of monthly return variance is due to transitory price changes (noise). The trading variables explain 40% of this transitory variance. A one standard deviation change in market makers’ positions (individuals’ net trades) is associated with transitory volatility of 1.52% (also 1.52%). The results are larger for smaller stocks (2.43% and 1.86%).
Number of Pages in PDF File: 49 Keywords: Transitory Volatility, Liquidity, Individual Investors, Market Makers JEL Classification: G12, G14 working papers seriesDate posted: August 1, 2010 ; Last revised: September 23, 2011Suggested CitationContact Information
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