Trading Volume: Implications of an Intertemporal Capital Asset Pricing Model

Authors


  • Lo is from MIT Sloan School of Management, and National Bureau of Economic Research (NBER), and Wang is from MIT Sloan School of Management, NBER, and China Center for Financial Research. The authors thank Joon Chae, Ilan Guedj, Jannette Papastaikoudi, Antti Petajisto, and Jean-Paul Sursock for excellent research assistance, and Jonathan Lewellen for providing his industry classification scheme. They are grateful to Wayne Ferson and seminar and conference participants at Boston College, the Chinese University of Hong Kong, Duke University, Georgetown University, Harvard Business School, London Business School, New York University, Oxford University, the Shenzhen Stock Exchange, UCLA, University of North Carolina, University of Pennsylvania, University of Toronto, the 8th World Congress of the Econometric Society, the 2001 Lectures in Financial Economics in Beijing and Taipei, the 2005 CORE Lectures at the Université Catholique de Louvain for helpful comments and suggestions. Financial support from the MIT Laboratory for Financial Engineering and the National Science Foundation (Grant No. SBR–9709976) is gratefully acknowledged.

ABSTRACT

We derive an intertemporal asset pricing model and explore its implications for trading volume and asset returns. We show that investors trade in only two portfolios: the market portfolio, and a hedging portfolio that is used to hedge the risk of changing market conditions. We empirically identify the hedging portfolio using weekly volume and returns data for U.S. stocks, and then test two of its properties implied by the theory: Its return should be an additional risk factor in explaining the cross section of asset returns, and should also be the best predictor of future market returns.

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