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RFS Advance Access first published online on April 13, 2009
This version published online on May 4, 2009
Review of Financial Studies, doi:10.1093/rfs/hhp021
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© The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org.

Information Linkages and Correlated Trading

Paolo Colla
Università Bocconi

Antonio Mele
London School of Economics

Send correspondence to Antonio Mele, London School of Economics, Houghton Street, London WC2A 2AE, United Kingdom; telephone: +44-20-71075371; Fax: +44-20-78494647. E-mail: a.mele{at}lse.ac.uk.


  Abstract

In a market with informationally connected traders, the dynamics of volume, price informativeness, price volatility, and liquidity are severely affected by the information linkages every trader experiences with his peers. We show that in the presence of information linkages among traders, volume and price informativeness increase. Moreover, we find that information linkages improve or damage market depth, and lower or boost the Traders' profits, according to whether these linkages convey positively or negatively correlated signals. Finally, our model predicts patterns of trade correlation consistent with those identified in the empirical literature: trades generated by "neighbor" traders are positively correlated and trades generated by "distant" traders are negatively correlated.

The references are updated.

We wish to thank Matthew Spiegel (the editor), an anonymous referee, Henry Cao, Marco Pagano, Andrea Prat, Jean-Charles Rochet, Randi Rosenblatt, Mark Seasholes, Hyun Shin, Dimitri Vayanos, Paolo Vitale, Johan Walden, and seminar participants at the Centre for Studies in Economics and Finance (Salerno), Ente Luigi Einaudi (Rome), ESSEC Business School (Paris), ISEG (Technical University of Lisbon), Instituto de Empresa Business School (Madrid), FMG-LSE, Norwegian School of Economics and Business Administration, Norwegian School of Management, Stockholm School of Economics, Universitat Pompeu Fabra, University of Toulouse, USI Lugano (Institute of Finance), the 2008 American Finance Association, CEPR/Studienzentrum Gerzensee ESSFM (2005), CORE Summer School (2005), the 12th Mitsui Life Symposium on Financial Markets (Information in Trading) at the Ross School of Business, Ann Arbor (2006), and the Society for Advancement in Economic Theory meeting in Vigo (2005) for very useful comments and suggestions. The first author acknowledges financial support provided through the European Community's Human Potential Programme under contract HPRN-CT-2002-00232. The second author thanks the British EPSRC for financial support via grant EP/C522958/1. The usual disclaimer applies.


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