Portfolio trading and information transmission in securities markets: Theory and evidence

This dissertation consists of three essays related to stock portfolio trading and information transmission in the security market. The first essay develops a model of trading in the stock and the stock index markets with transaction costs. We study the properties of security prices with cross-market informational trading in the presence of transaction costs and show that introduction of stock index securities improves the dissemination of market-wide information. The model further investigates the causes and consequences of index arbitrage and the bi-directional lead-lag relation between the index and the stock markets. Using S&P 500 index futures data, the essay empirically test one implication of the model that movements in index basis predict index and stock returns. The empirical evidence is consistent with model predictions.;The second essay applies the model developed in the first essay to examine the implications of closed-end fund trading on the variation and information content of closed-end fund discounts. The model provides a rational expectation explanation for the time series properties of closed-end fund discounts based on information transmission across securities. The model shows that closed-end fund discounts can predict fund net asset value returns as well as fund price returns, but based on different information. Using weekly data on a sample of U.S. general equity closed-end funds and controlling the difference between systematic information and security specific information, we find strong evidence supporting the model.;The third essay investigates the trading process and information content in the after-hour index futures market. Using S&P 500 index futures trading data, we study the interaction between the index security market and stock market and the interaction between the regular hour trading session and the after-hour trading session. We find that after-hour trades are associated with significant price discovery. After-hour trading volumes are small, but they process information efficiently and do not distort price movements. The empirical results also support the notion that the index futures market and the stock market are well integrated. The stock market incorporates after-hour index price information very quickly and arbitrage opportunities at the stock market opening are short lived.