Working Paper Alfred P. Sloan School of Management Trading Volume with Private Valuations: Theory and Evidence from the Ex-dividend Day Theory and Evidence from the Ex-dividend Day

We develop and test a theory of the interaction between investors' heterogeneity, risk, transactions costs and trading volume. To test our model we take advantage of the specific nature of trading motives around the distribution of cash dividends namely the costly trading of tax shields. Consistent with the theory, we show that when trades occur because of differential valuation of cash flows an increase in risk or transactions costs reduces volume. It is also shown that the non-systematic risk plays a significant role in determining the volume of trade. Finally, we demonstrate that trading volume is positively related to the degree of heterogeneity and the incentives of the various groups to engage is trading.