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An Epidemiological Approach to Opinion and Price-Volume Dynamics

50 Pages Posted: 13 Mar 2010 Last revised: 13 Nov 2013

Dong Hong

Singapore Management University - Lee Kong Chian School of Business

Harrison G. Hong

Columbia University, Graduate School of Arts and Sciences, Department of Economics; National Bureau of Economic Research (NBER)

Andrei Ungureanu

Princeton University

Date Written: January 3, 2011

Abstract

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.

Keywords: Word of Mouth, Information Diffusion, Public News, Private News

JEL Classification: G10, G12, G14

Suggested Citation

Hong, Dong and Hong, Harrison G. and Ungureanu, Andrei, An Epidemiological Approach to Opinion and Price-Volume Dynamics (January 3, 2011). AFA 2012 Chicago Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1569418 or http://dx.doi.org/10.2139/ssrn.1569418

Dong Hong

Singapore Management University - Lee Kong Chian School of Business ( email )

50 Stamford Road
178899
Singapore

Harrison G. Hong (Contact Author)

Columbia University, Graduate School of Arts and Sciences, Department of Economics ( email )

420 W. 118th Street
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Andrei Ungureanu

Princeton University ( email )

22 Chambers Street
Princeton, NJ 08544
United States

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