Risk Aversion, Liquidity, and Endogenous Short Horizons

Avanidhar Subrahmanyam

University of California, Los Angeles (UCLA) - Finance Area

Craig W. Holden

Indiana University - Department of Finance

We analyze trading behavior and information acquisition in a competitive rational expectations model in which different information signals get reflected in value at different points in time (in the short-term and in the long-term). If investors are sufficiently risk averse, we obtain a unique equilibrium in which the entire mass of investors endogenously focuses on the short-term and thereby neglects long-run fundamentals. We also show that ``too much'' market liquidity (in the form of a large variance of informationless trading) causes a greater proportion of investors to focus on the short-term signal, which decreases the informativeness of prices about long-run determinants of value. Further, we show that long-term informed agents optimally postpone heavy trading until after the disclosure of public signals which partly resolve the uncertainty surrounding true value. This is consistent with empirical evidence of increases in trading volume immediately following quarterly earnings announcements. Finally, we explore an alternative framework in which informed agents may voluntarily and credibly disclose their information following an initial round of trade. We explore parameter spaces under which such disclosure is optimal.

JEL Classification: G12, G14

working papers series

Not Available For Download

Date posted: June 13, 1994  

Suggested Citation

Subrahmanyam, Avanidhar and Holden, Craig W., Risk Aversion, Liquidity, and Endogenous Short Horizons. Available at SSRN: http://ssrn.com/abstract=5353

Contact Information

Avanidhar Subrahmanyam (Contact Author)
University of California, Los Angeles (UCLA) - Finance Area ( email )
Los Angeles, CA 90095-1481
United States
310-825-5355 (Phone)
310-206-5455 (Fax)
Craig W. Holden
Indiana University - Department of Finance ( email )
Kelley School of Business
1309 E. 10th St.
Bloomington, IN 47405
United States
812-855-3383 (Phone)
812-855-5875 (Fax)
HOME PAGE: www.kelley.iu.edu/cholden
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