Trading Volume: Implications of an Intertemporal Capital Asset Pricing Model

65 Pages Posted: 25 Oct 2001 Last revised: 29 May 2022

See all articles by Andrew W. Lo

Andrew W. Lo

Massachusetts Institute of Technology (MIT) - Laboratory for Financial Engineering

Jiang Wang

Massachusetts Institute of Technology (MIT) - Sloan School of Management; China Academy of Financial Research (CAFR); National Bureau of Economic Research (NBER)

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Date Written: October 2001

Abstract

We derive an intertemporal capital asset pricing model with multiple assets and heterogeneous investors, and explore its implications for the behavior of trading volume and asset returns. Assets contain two types of risks: market risk and the risk of changing market conditions. We show that investors trade only in two portfolios: the market portfolio, and a hedging portfolio, which allows them to hedge the dynamic risk. This implies that trading volume of individual assets exhibit a two-factor structure, and their factor loadings depend on their weights in the hedging portfolio. This allows us to empirically identify the hedging portfolio using volume data. We then test the two properties of the hedging portfolio: its return provides the best predictor of future market returns and its return together with the return of the market portfolio are the two risk factors determining the cross-section of asset returns.

Suggested Citation

Lo, Andrew W. and Wang, Jiang, Trading Volume: Implications of an Intertemporal Capital Asset Pricing Model (October 2001). NBER Working Paper No. w8565, Available at SSRN: https://ssrn.com/abstract=288478

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Jiang Wang

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