A Rational Expectations Equilibrium with Informative Trading Volume
49 Pages Posted: 25 Jan 2009 Last revised: 26 Jan 2009
Date Written: January 24, 2009
Abstract
A large number of empirical studies find that trading volume contains information about the distribution of future returns. While these studies indicate that observing volume is helpful to an outside observer of the economy it is not clear how investors within the economy can learn from trading volume. In this paper I show how trading volume helps investors to evaluate the precision of the aggregate information in the price. I construct a model that offers a closed form solution of a rational expectations equilibrium where all investors learn from (1) private signals, (2) the market price and (3) aggregate trading volume.
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