Differential Interpretation of Information and Trade in Speculative Markets

Most models of trade in speculative markets make the assumption that agents interpret public information identically. We provide empirical evidence that this assumption is overly restrictive. We begin by investigating the relation between the volume of trade and stock returns (NYSE, AMEX and NASDAQ-listed stocks) around anticipated public announcements, and find that there is a significant abnormal volume even when prices do not change in response to the announcement. We argue that this is likely due to the differences in interpretation of public information by investors. We then develop a model of trade which incorporates differential interpretations and show that its predictions are consistent with the observed volume-return relation. We go on to present a simple model of beliefs revision, which underlies our and many other models of trade and test it on the stock brokerage research analyst's earning forecasts taken from the I/B/E/S Detail Tape. The hypothesis that agents use the same model to interpret public announcements is inconsistent with the forecast revisions in this data