Differential Information and Dynamic Behavior of Stock Trading Volume.

We develop a multi-period model of stock trading in which investors receive differential information concerning the underlying value of the stock. Investors trade competitively in the market based on their own private information and the information revealed by the market clearing prices as well as other public news. By showing that the hierarchy of expectations (i.e., forecasting the forecasts of others) is a closed system, we resolve the infinite regress problem that is common to intertemporal models with differential information and derive a rational expectations equilibrium. We analyze the dynamic behavior of equilibrium trading volume. In particular, we examine how trading volume is related to the information flow to the market and how investors' trading reveals their private information.