Trading volume, Information precision and Transaction costs: A closer look

Hua Cheng, University of Paris Dauphine

ABSTRACT. We decompose the relation between trading volume and precision of public announcement into three parts: the first part denotes the influence of differential interpretation for public announcement and is always positive; the second denotes different precision of previous private information and may be positive or negative; the third denotes the influence of transaction costs and is always negative.

While our model may generate traditional positive relation between trading volume and the precision under no transaction costs, this relation may also be negative when traders interpret public information in the same way. Whether public information is identically interpreted or not, the effect of transaction costs may denominate that of the different precision of previous private information and trading volume is firstly increasing and then decreasing in the precision. Our argument helps reconcile several puzzling empirical results on trading volume reactions to public announcement.

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