Long-Term Information, Short-Lived Securities

Journal of Futures Markets, Vol. 26, No. 5, pp. 465-502, 2006

Posted: 8 Sep 2005

See all articles by Dan Bernhardt

Dan Bernhardt

University of Illinois at Urbana-Champaign - Department of Economics

Ryan J. Davies

Babson College - Finance Division

John Spicer

European Economic Research Ltd.

Multiple version iconThere are 2 versions of this paper

Abstract

This paper explores strategic trade in short-lived securities by agents who have private information that is potentially long-term, but do not know how long their information will remain private. Trading short-lived securities is profitable only if enough of the private information becomes public prior to contract expiration; otherwise the security will worthlessly expire. We highlight how this results in trading behavior fundamentally different from that observed in standard models of informed trading in equity. Specifically, we show that informed speculators are more reluctant to trade shorter-term securities too far in advance of when their information will necessarily be made public, and that existing positions in a shorter-term security make future purchases more attractive. Because informed speculators prefer longer-term securities, this can make trading shorter-term contracts more attractive for liquidity traders. We characterize the conditions under which liquidity traders choose to incur extra costs to roll over short-term positions rather than trade in distant contracts, providing an explanation for why most longer-term derivative security markets have little liquidity and large bid-ask spreads.

Keywords: Private information, Derivative securities, Rolling the hedge, Fixed transaction costs

JEL Classification: G1, D82

Suggested Citation

Bernhardt, Dan and Davies, Ryan J. and Spicer, John, Long-Term Information, Short-Lived Securities. Journal of Futures Markets, Vol. 26, No. 5, pp. 465-502, 2006, Available at SSRN: https://ssrn.com/abstract=797546

Dan Bernhardt

University of Illinois at Urbana-Champaign - Department of Economics ( email )

1206 South Sixth Street
Champaign, IL 61820
United States
217-244-5708 (Phone)

Ryan J. Davies (Contact Author)

Babson College - Finance Division ( email )

220 Tomasso Hall
Babson Park, MA 02457-0310
United States
781-239-5345 (Phone)
781-239-5004 (Fax)

HOME PAGE: http://www.ryanjdavies.net

John Spicer

European Economic Research Ltd. ( email )

Chancery House
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London WC2A 1QU
United Kingdom
+44 20 7831 4717 (Phone)
+44 20 7831 4515 (Fax)

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