Trading Volume and Changes in Heterogeneous Expectations

Larry Lang and Robert H. Litzenberger

Rodney L. White Center for Financial Research Working Papers from Wharton School Rodney L. White Center for Financial Research

Abstract: A comparative static analysis of a competitive equilibrium under heterogeneous earn-ings expectations and constant absolute risk aversions demonstrates that unsystem-atic trading volume in response to a public information release is proportional to the change in relative heterogeneity of beliefs and is unrelated to either the dispersion of prior beliefs or the absolute change in the consensus expectation. In contrast, under homogeneous expectations and non-constant absolute risk aversions, total trading volume is a function of the absolute change in the consensus earnings expectation. Using a large number of individual analysts’ annual earnings forecasts, the change in relative heterogeneity and the absolute change in the consensus expectation are measured around interim quarterly earnings reports and shown to possess predicted impacts on trading volume.

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