[We test a theory of the interaction between investors' heterogeneity, risk, transaction costs, and trading volume. 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 transaction costs reduces volume. We also show that the nonsystematic 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 in trading.]

Unit time costs, or holding costs, are incurred in many arbitrage contexts. Examples include losing the use of short sale proceeds and lending funds at below market rates in reverse repurchase agreements. This paper analyzes the investment problem of a risk-averse arbitrageur who faces holding costs. The model allows prices to deviate from "fundamental" values without allowing for riskless arbitrage opportunities. After characterizing an arbitrageur's optimal strategy, the model is examined in the context of the Treasury market. The analysis reveals that holding costs are an important friction in this market and that they can significantly affect arbitrageur behavior.

Unit time costs, or holding costs, are incurred in many arbitrage contexts. Examples include losing the use of short sale proceeds and lending funds at below market rates in reverse repurchase agreements. This paper analyzes the investment problem of a risk averse arbitrageur who faces holding costs. The model allows prices to deviate from “fundamental” values without allowing for riskless arbitrage opportunities. After characterizing an arbitrageur's optimal strategy, the model is examined in the context of the Treasury market. The analysis reveals that holding costs are an important friction in this market and that they can significantly affect arbitrageur behavior.

We solve for the optimal dynamic trading strategy of an investor who faces a leverage constraint, i.e., a limitation on his ability to borrow for the purpose of investing in a risky asset. We assume that the investor has constant relative risk aversion, and that the value of the risky asset follows a geometric Brownian motion. In the absence of the leverage constraint, the optimal strategy involves investing a fixed proportion of wealth in the risky asset. We prove that, in the presence of the leverage constraint, the optimal investment also involves investing a fixed proportion of wealth in the risky asset when the leverage constraint is not binding. However, the two proportions are different, reflecting the extent to which the investor alters his strategy even when the leverage constraint is not binding because of the possibility that the leverage constraint will become binding in the future.

This paper analyzes the relationship between tax heterogeneity and the behavior of stock prices and volume around the ex-dividend day within an equilibrium framework.We conclude that, even in a world without transaction costs, the price drop on the ex-day need not be equal to the dividend amount.The model allows us to account for higher market trading volume around the ex-day.The market trading volume is shown to be a positive function of tax heterogeneity among traders.We show that the volume of trade around the ex-day contains information about investors' tax preferences above and beyond the information contained in the ex-day price alone.Consistent with the model's predictions, our empirical analysis reveals that as the risk associated with the ex-dividend day increases, or tax heterogeneity decreases, trading volume decreases.constant), the abnormal volume of trade significantiy decreases.Using the period around the 1986 TRA, we are also able to show that a change in the degree of tax heterogeneity affects both prices and volume around the ex-dividend day.Our analysis shows that unless a perfect tax clientele exists, it is not possible to infer tax rates from price alone.[By a perfect tax clientele we mean that each tax group hold different securities, and all trading is intra-group trading.See Miller and Modigliani (1961) and Elton and Gruber (1970)].However, the crosssectional distribution of tax rates can be inferred by using both price and volume data.This point can be illustrated using the following stylized example.Assume that there are three groups of traders in the marketplace with a marginal rate of substitution between dividends and capital gains income of 0.75, 1.0, and 1.25, respectively.Assume further that the average price drop relative to the dividend amount is 1.0.Using the standard analysis, we may conclude that the second group dominates the ex-dividend day price determination.However, this may not be the case.For example, suppose that 50% of the traders are from the first group, 50%

We test a theory of the interaction between investors’ heterogeneity, risk, transaction costs, and trading volume. 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 transaction costs reduces volume. We also show that the nonsystematic 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 in trading.

This document contains a list of one typo in the main text and six typos in the online appendix of the article. Each typo is followed by an explanation of why it is only a typo and does not affect the analysis in the article. The main text and online appendix refer to the documents in the journal’s website https://www.econometricsociety.org/publications/ econometrica/2021/01/01/preferred-habitat-model-term-structure-interest-rates.

We develop a model of trading volume when agents have different valuation and face transaction costs. In particular, the differential valuation is induced by differential tax status which generates trading around the distribution of cash dividends. Our model predicts that trading volume is negatively affected by idiosyncratic risk of dividend-paying stocks. Volume is negatively affected by the systematic risk of these stocks only in the presence of transaction costs.Journal of Economic LiteratureClassification Numbers: G11, G12, H20.