Differences of Opinion of Public Information and Speculative Trading in Stocks and Options

Abstract

This paper develops a model of trading in stocks and options based on differences of opinion of public information among risk-averse investors. It shows that both additional trading sessions and the introduction of options enhance investors' perceived welfare and that in the presence of options, the trading volume of the underlying stock is positive even if the stock price remains unchanged. Some unique empirical implications are that the trading volume of options increases with both the arrival of public information and the dispersion of investors' interpretation of it, and that the introduction of options makes the trading volume of the underlying stock both higher and more sensitive to the price changes of the underlying stock.

Keywords: High Confidence, Low Confidence, Differential Interpretation of Public Information