Trading Volume, Price Autocorrelation and Volatility under Proportional Transaction Costs.

We develop a dynamic model in which traders have differential information about the payoff of the risky asset and trade the risky asset with proportional transaction costs. Firstly, trading volume provides useful information on the asset fundamental value which cannot be inferred from the equilibrium price. Secondly, price autocorrelation can be generated only by proportional transaction costs. Thirdly, we show that return volatility may be and generally is increasing in proportional transaction costs, which is contrary to Stiglitz 1989, Summers & Summers 1989's reasoning but is consistent with Umlauf 1993 and Jones & Seguin 1997's empirical results.