Information Flow And Trading Dynamics: A Theoretical Approach

Abstract

This paper constructs a theoretical mixture of distributions model to describe the impacts of permanent fundamental, transitory fundamental, and non-fundamental shocks on returns, volatility and volume.  Under the assumption that informed traders share homogenous fundamental information, we find that only contemporaneous noise trading contributes to the generation of trading volume.  This theoretical model provides us with three identifying restrictions that can be readily imposed on a trivariate SVAR model to empirically estimate the impacts of the three shocks on returns, volatility, and volume.  Using this model, we find that Microsoft stock prices are not very sensitive to noise trading.