Information Precision, Transaction Costs, and Trading Volume
17 Pages Posted: 29 Oct 1997 Last revised: 21 Jun 2017
Date Written: June 10, 2004
Models of trade by Pfleiderer (1984), Holthausen and Verrecchia (1990), and Kim and Verrecchia (1991) imply that the trading volume prompted by a public announcement is positively related to the announcement's precision. Relying upon this notion, empirical researchers interpret high trading volume as an indication that an announcement is highly informative. We show that such interpretations can be incorrect. In a world with transaction costs, the relation between information precision and trading volume is ambiguous, and can be negative. This explains why, in empirical tests, the relation between announcement precision and trading volume is not monotonically positive, even though in laboratory experiments it is. Cross-sectionally, our results imply that trading volume reactions to highly informative announcements will be positive primarily for low-transaction cost securities.
JEL Classification: G14, D81, D82
Suggested Citation: Suggested Citation