Long-Term Information, Short-Lived Securities
Journal of Futures Markets, Vol. 26, No. 5, pp. 465-502, 2006
Posted: 8 Sep 2005
There 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: Suggested Citation