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Differences Of Opinion Of Public Information And Speculative Trading In Stocks And Options
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Category : Business » Stock Trading
. literature in which the trading volume of a stock is typically related to its own . will no longer trade in either the underlying stock or the option .
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This paper develops a model of trading in stocks and options based on differences of opinion of public information among risk-averse investors. It is shown that when investors disagree about the precision of a signal, options are not redundant assets. Even when the disagreement about the precision is arbitrarily small (e.g., in the order of 1/√T with T approaching infinity) and trading takes place arbitrarily frequently, the investors’ perceived gains in trading stocks approach zero but those in trading options remain positive. It is also shown that the volatility implied by the option price may not be the realized volatility of the stock price. The expected returns are positively related to both the implied volatility and the realized volatility. When the implied volatility is higher than the realized volatility, the expected stock returns can exhibit positive serial autocorrelations. Moreover, trading in the underlying stock depends on its price change as well as the open interest in options. In a multiple stock setting, it is further shown that the trading volume of a stock can be positive even when there is no price change for that stock, and it depends not only on the investors’ differences of opinion about that stock’s payoff but also on their differences of opinion about the payoffs of other related stocks.
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