Imperfect Information and Cross-Autocorrelation among Stock Prices

I develop a model to explain why stock returns are positively cross-autocorrelated. When market makers observe noisy signals about the value of their stocks but cannot instantaneously condition prices on the signals of other stocks, which contain marketwide information, the pricing error of one stoc...

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Bibliographic Details
Published in:The Journal of finance (New York) 1993-09, Vol.48 (4), p.1211-1230
Main Author: CHAN, KALOK
Format: Article
Language:English
Subjects:
Autocorrelation
Coefficients
Correlation analysis
Economic models
Economic theory
Market conditions
Market prices
Price changes
Price level changes
Prices
Pricing policies
Security prices
Signal noise
Stock market indices
Stock prices
Studies
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Summary:I develop a model to explain why stock returns are positively cross-autocorrelated. When market makers observe noisy signals about the value of their stocks but cannot instantaneously condition prices on the signals of other stocks, which contain marketwide information, the pricing error of one stock is correlated with the other signals. As market makers adjust prices after observing true values or previous price changes of other stocks, stock returns become positively cross-autocorrelated. If the signal quality differs among stocks, the cross-autocorrelation pattern is asymmetric. I show that both own- and cross-autocorrelations are higher when market movements are larger.
ISSN:0022-1082
1540-6261
DOI:10.1111/j.1540-6261.1993.tb04752.x