Does anticipated information impose a cost on risk-averse investors

This paper theoretically and empirically investigates how the risk of future adverse price changes created by the anticipated arrival of information influences risk-averse investors' trading decisions in institutionally imperfect capital markets. Specifically, I examine how trading volume is influenced by the trade-off between risk-sharing benefits of immediate trade to mitigate exposure to future adverse price changes, and explicit transaction costs imposed on such trades. Employing a stylized model, I demonstrate that current trading decisions depend upon two aspects of risk: the expected intensity of future price fluctuations per unit of time, and the duration of time that risk must be borne. Tension in the model is created by introducing an incremental capital gains tax rate applied to trading profits on shares held for less than a requisite amount of time. Thus, risk-averse investors face an economic tension between trading immediately to an optimal risk-sharing portfolio at the cost of incurring an incremental tax on realized trading profits, versus postponing trade to avoid the incremental tax while facing the risk of interim, adverse price changes. The fact that investors can reduce tax costs by postponing the sale of shares until a known, future point in time creates a unique opportunity to empirically investigate the impact of the duration of risk on trading behavior. Consistent with the model's predictions, I document that as the number of days left to avoid the incremental tax increases (i.e., duration of risk increases), trading volume around quarterly earnings announcements is less sensitive to the incremental tax on short-term trading profits. Similarly, as the expected volatility of future stock price increases (i.e., intensity increases), current trading volume is again less sensitive to incremental tax costs. These results suggest that investors are more willing to incur explicit tax costs in order to insulate themselves against increases in the risk of price fluctuations driven by increases in the duration or intensity of risk.