Information Linkages and Correlated Trading

Abstract:     
In a market with informationally connected traders, the dynamics of volume, price informativeness, price-volatility, and price-impacts are severely affected by the number of information linkages every trader experiences with his neighbors. We show that in the presence of information linkages among traders, volume and price informativeness increase and price-impacts lower. Moreover, we find that information linkages boost or damage the traders' profitability according to whether such linkages convey negatively or positively correlated signals. Finally, our model predicts patterns of trades correlation consistent with patterns of trades correlation identified in the empirical literature: 'neighbor' trades are positively correlated and 'distant' trades are negatively correlated.

Number of Pages in PDF File: 53

Keywords: market microstructure, information linkages

JEL Classification: D82, D83, D84, G12, G14

working papers series