How (Un)Informed Is Trading?

We estimate a structural model of strategic trader behavior that sheds light on the determinants of trading volume and stock returns. Our novel identification approach exploits enormous empirical variation in trading and volatility associated with the time of day and public news arrival. Over 95% of trading occurs during regular market hours (9:30am to 4pm), even though prices exhibit considerable volatility during extended hours, especially when news arrives. For the model to explain the data, discretionary liquidity trading must constitute the bulk of trading volume and must increase significantly after news arrives. However, from 2001 to 2010, informed trading increasingly contributes to volume and stock price discovery because our estimate of the cost of acquiring private information falls by a factor of 12 in this decade. * University of Arizona, [email protected] and Columbia University, [email protected]. An earlier version of this paper circulated under the title “Round-the-Clock News, Trading, and Returns.” We thank Lauren Cohen, Rick Sias, and seminar participants at Arizona, Columbia, Georgia, and Tennessee for helpful discussions and Dow Jones for providing the news data used in this study.