Uninformed Trading and Asset Prices

46 Pages Posted: 26 Apr 2005 Last revised: 3 Jan 2009

See all articles by Sandro C. Andrade

Sandro C. Andrade

University of Miami - Department of Finance

Charles Chang

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF)

Mark S. Seasholes

ASU WP Carey School of Business

Date Written: November 5, 2004

Abstract

This paper examines the relationship between uninformed trading and asset prices. We outline a simple market clearing model in which some traders have demands shocks that are uncorrelated with asset fundamentals. We verify the predictions of the model empirically using an untapped dataset that allows ex ante identification of uninformed demand shocks. Our results show pervasive price pressure at a daily, weekly and monthly frequency. A zero-cost portfolio based on past uninformed trades earns up to 171 bp (before transaction costs) over the subsequent three week period. Returns of this zero-cost portfolio cannot be explained by known sources of systematic risk. Within the same modeling framework, we show that uninformed trading is also related to permanent price differences across stocks. Stocks that are subject to more volatile uninformed trading earn higher average returns. Our results provide insights into the limits of arbitrage and a market's ability to absorb aggregate demand shocks.

Keywords: Asset pricing, return predictability, limits of arbitrage

JEL Classification: G12

Suggested Citation

Andrade, Sandro C. and Chang, Charles and Seasholes, Mark S., Uninformed Trading and Asset Prices (November 5, 2004). Available at SSRN: https://ssrn.com/abstract=618621 or http://dx.doi.org/10.2139/ssrn.618621

Sandro C. Andrade

University of Miami - Department of Finance ( email )

P.O. Box 248094
Coral Gables, FL 33124-6552
United States

HOME PAGE: http://moya.bus.miami.edu/~sandrade/

Charles Chang

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

Mark S. Seasholes (Contact Author)

ASU WP Carey School of Business ( email )

Dept of Finance, BAC 501
400 E. Lemon St.
Tempe, AZ 85287-3906
United States

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