Journal Article

Informed Trading and Portfolio Returns

Alex Boulatov, Terrence Hendershott and Dmitry Livdan

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 80, issue 1, pages 35-72
Published in print January 2013 | ISSN: 0034-6527
Published online April 2012 | e-ISSN: 1467-937X | DOI:
Informed Trading and Portfolio Returns

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  • Market Structure and Pricing


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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.

Keywords: Market efficiency; Strategic trading; Information asymmetry; Learning; D4; G1; G12; G14

Journal Article.  13492 words.  Illustrated.

Subjects: Economics ; Market Structure and Pricing

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