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Differential Interpretations and Trading Volume

Published online by Cambridge University Press:  06 April 2009

Linda Smith Bamber ,
Orie E. Barron  and
Thomas L. Stober
Linda Smith Bamber
Affiliation:
University of Georgia, Terry College of Business, 255 Brooks Hall, Athens, GA 30602
Orie E. Barron
Affiliation:
Pennsylvania State University, 203 Beam Business Administration Building, University Park, PA 16802
Thomas L. Stober
Affiliation:
University of Notre Dame, College of Business Administration, Notre Dame, IN 46556
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Abstract

This study provides evidence that differential interpretations are an important stimulus for speculative trading. We measure differential interpretations using data on analysts' revisions of forecasts of annual earnings after the announcement of quarterly earnings that are components of those annual earnings numbers. We find two conditions under which differential interpretations play a significant role in explaining trading. First, we present empirical evidence supporting Kandel and Pearson's (1995) argument that trading coincident with small price changes reflects investors' differential interpretations of information. This evidence is important because it is inconsistent with conventional models of trade that assume homogeneous interpretations. Second, we also find that differential interpretations explain a significant amount of the trading occurring in a sample where trading volume is higher than the (firm-specific) non-announcement period average. This result is consistent with informed traders acting on their differential interpretations when there is enough liquidity trading to help camouflage their own information-based trades. In sum, the study's results confirm Bachelier's (1900) intuition that differential interpretations are an important stimulus for trading.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 34 , Issue 3 , September 1999 , pp. 369 - 386
Copyright
Copyright © School of Business Administration, University of Washington 1999

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