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Long‐term information, short‐lived securities

Author

Listed:
  • Dan Bernhardt
  • Ryan J. Davies
  • John Spicer
Abstract
The authors explore strategic trade in short‐lived securities by agents who have private information that is potentially long‐term, but do not know how long their information will remain private. Trading short‐lived securities is profitable only if enough of the private information becomes public prior to contract expiration; otherwise the security will worthlessly expire. How this results in trading behavior fundamentally different from that observed in standard models of informed trading in equity is highlighted. Specifically, it is shown that informed speculators are more reluctant to trade shorter‐term securities too far in advance of when their information will necessarily be made public, and that existing positions in a shorter‐term security make future purchases more attractive. Because informed speculators prefer longer‐term securities, this can make trading shorter‐term contracts more attractive for liquidity traders. The conditions are characterized under which liquidity traders choose to incur extra costs to roll over short‐term positions rather than trade in distant contracts, providing an explanation for why most longer‐term derivative security markets have little liquidity and large bid‐ask spreads. © 2006 Wiley Periodicals, Inc. Jrl Fut Mark 26:465–502, 2006

Suggested Citation

  • Dan Bernhardt & Ryan J. Davies & John Spicer, 2006. "Long‐term information, short‐lived securities," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 26(5), pages 466-502, May.
    • Handle: RePEc:wly:jfutmk:v:26:y:2006:i:5:p:466-502
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    References listed on IDEAS

    as
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    Cited by:

    1. Chris Brooks & Ryan J. Davies & Sang Soo Kim, 2005. "Cross Hedging with Single Stock Futures," ICMA Centre Discussion Papers in Finance icma-dp2004-15, Henley Business School, University of Reading.

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    More about this item

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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