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Informed Trading and Portfolio Returns

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  • Alex Boulatov
  • Terrence Hendershott
  • Dmitry Livdan

Abstract

We solve a multi-period model of strategic trading with long-lived information in multiple assets with correlated innovations in fundamental values. Market makers in each asset can only condition their pricing functions on trading in each asset. Using daily non-public data from the New York Stock Exchange, we test the model's predictions on the conditional and unconditional lead--lag relations of institutional order flow and returns within portfolios. We find support for the model prediction of positive autocorrelations in portfolio returns as well as the predictions for how informed order flow positively predicts future returns and future informed order flow. We show that these relations strengthen for portfolios formed from assets within the same industry, which likely have higher correlation of fundamental values. Furthermore, we discuss issues that arise when testing implications of strategic models with imperfect proxies for the underlying strategic behaviour. Copyright , Oxford University Press.

Suggested Citation

  • Alex Boulatov & Terrence Hendershott & Dmitry Livdan, 2013. "Informed Trading and Portfolio Returns," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 80(1), pages 35-72.
    • Handle: RePEc:oup:restud:v:80:y:2013:i:1:p:35-72
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    File URL: http://hdl.handle.net/10.1093/restud/rds020
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