Information asymmetry, price changes, trading volume and bid-ask spreads: Two essays

• Main Author: Chopra, Vijay Kumar
• Format: Dissertation
• Language: English
• Published: ProQuest Dissertations & Theses 01-01-1990
• Subjects: Finance; Management
• ISBN: 9798641495576

This dissertation examines the impact of information asymmetry on the behavior of prices and trading volume. The patterns in prices and trading volume arising out of the interaction of informed and uninformed traders is the subject of the first essay, "A theory of Price Changes and Trading Volume". In the proposed theoretical model, trading occurs due to changing liquidity needs, speculation and release of new information. In the basic two period case, new information relevant to asset valuation becomes available to the group of informed traders in the first period, and becomes public in the second period. The intermediate price conveys some information to the uninformed. Simulation is used to analyze the behavior of key variables of interest. The theory predicts an increase in trading volume with information asymmetry. As the proportion of informed traders increases, the intermediate price becomes more informative. Early access to information enables informed traders to expropriate wealth from the uninformed. As the number of informed traders increases, the resulting competition among them reduces the expropriation. The model is extended to a multiperiod setting by considering a series of overlapping two-period models. While asset pricing models like the CAPM and the APT predict asset returns over time, this paper focuses on the mechanism by which a piece of information translates into a price change and generates trading over the short run. The second essay, "Information Asymmetry Before Earnings and Dividend Announcements: An Empirical Investigation", seeks to detect information asymmetry before informational announcements through the price setting behavior of the dealer. If earnings and dividend announcements are preceded by a period of increased information asymmetry, rational market makers will widen the bid-ask spreads to cover losses incurred in trading with informed traders. Though theoretical models predict a widening of the spread due to increased information asymmetry, earlier evidence of such an effect is mixed. This study documents a significant widening of the spread before earnings and dividend announcements. The influence of factors like the level of trading activity, information surprise, firm size and price on spread variations is also examined.