D.W.Diamond and R.E.Verrecchia,Price adjustment to private information 281 Formally,we model liquidity trading as a shock to an individual's time preference.All traders discount future consumption by the factor p,so the present utility value of consumption,Cr,on the date of the liquidating dividend,is p x Cr.We assume that absent a shock,p equals one.Unin- formed traders (but no one else)receive one of two possible shocks:either p =0,which implies that one sells the asset to satisfy consumption today,or p=+oo,which implies that one buys the asset as a means of deferring consumption indefinitely.Modeling preference shocks as we do is a'reduced form'for many possibilities.We use extreme values purely for simplicity of interpretation.The Glosten-Milgrom (1985)model is consistent with more general shocks and types of private information.Some motive for trade other than speculative profit is necessary to construct a model of trade by unin- formed individuals:unless they have some potential gains from trade,they will be unwilling to pay the bid-ask spread.Nothing of substance depends on the assumption that only uninformed traders are subject to liquidity shocks. To offer the simplest setting for the role of information and liquidity shocks toward generating observable trades,we abstract from the possible variations in the size of trades established by traders.Specifically,a trader is allowed to buy a single share,sell a single share,short-sell a single share,or do nothing. For example,if a trader is informed and observes that the stock is underpriced at the ask price,he then buys one share and holds it (because under our assumptions,it will never subsequently become overpriced at the bid).Simi- larly,if a trader receives a liquidity shock and has a desire to invest (i.e.. p=+co),he buys one share.If a trader who already owns the stock finds it overpriced at the bid price or receives a liquidity shock and must sell (i.e., p=0).he sells one share. A trader's willingness to short-sell is influenced by the cost associated with this transaction.We assume a simple cost function that is independent of a trader's level of information or type of liquidity shock.The cost associated with selling short falls into one of three categories:no-cost,proceeds-restric- tions,and short-prohibitions.The no-cost scenario allows full reinvestment or consumption of short-sale proceeds,implying that a short-sale generates funds on its initiation date.The proceeds-restrictions scenario delays receipt of proceeds.In this circumstance a short-sale generates no funds today but does allow one to profit if the price falls.Finally,short-prohibitions eliminate any opportunity to short-sell,either because an individual trader is prohibited from engaging in this activity,or the cost is so high that no trader would avail himself of the opportunity regardless of what he knows.We represent that fraction of the population which encounters no cost associated with short-sell- ing by c,that fraction which faces proceeds-restrictions by c2,and that fraction which is essentially prohibited from this activity by c3.All traders, independent of whether they are informed or uninformed,fall into one of these three categories,i.e.,c+c2+c3=1 at all times.Under the assumptionD. W. Diamond and R. E. Verrecchia. Puce adjustment roprioate information 281 Formally, we model liquidity trading as a shock to an individual’s time preference. All traders discount future consumption by the factor p, so the present utility value of consumption, Cr. on the date of the liquidating dividend, is p X Cr. We assume that absent a shock, p equals one. Unin￾formed traders (but no one else) receive one of two possible shocks: either p = 0, which implies that one sells the asset to satisfy consumption today, or p = + cc, which implies that one buys the asset as a means of deferring consumption indefinitely. Modeling preference shocks as we do is a ‘reduced form’ for many possibilities. We use extreme values purely for simplicity of interpretation. The Glosten-Milgrom (1985) model is consistent with more general shocks and types of private information. Some motive for trade other than speculative profit is necessary to construct a model of trade by unin￾formed individuals: unless they have some potential gains from trade, they will be unwilling to pay the bid-ask spread. Nothing of substance depends on the assumption that only uninformed traders are subject to liquidity shocks. To offer the simplest setting for the role of information and liquidity shocks toward generating observable trades, we abstract from the possible variations in the size of trades established by traders. Specifically, a trader is allowed to buy a single share, sell a single share, short-sell a single share, or do nothing. For example, if a trader is informed and observes that the stock is underpriced at the ask price, he then buys one share and holds it (because under our assumptions, it will never subsequently become overpriced at the bid). Simi￾larly, if a trader receives a liquidity shock and has a desire to invest (i.e., p = + co), he buys one share. If a trader who already owns the stock finds it overpriced at the bid price or receives a liquidity shock and must sell (i.e., p = 0), he sells one share. A trader’s willingness to short-sell is influenced by the cost associated with this transaction. We assume a simple cost function that is independent of a trader’s level of information or type of liquidity shock. The cost associated with selling short falls into one of three categories: no-cost, proceeds-restric￾tions, and short-prohibitions. The no-cost scenario allows full reinvestment or consumption of short-sale proceeds, implying that a short-sale generates funds on its initiation date. The proceeds-restrictions scenario delays receipt of proceeds. In this circumstance a short-sale generates no funds today but does allow one to profit if the price falls. Finally, short-prohibitions eliminate any opportunity to short-sell, either because an individual trader is prohibited from engaging in this activity, or the cost is so high that no trader would avail himself of the opportunity regardless of what he knows. We represent that fraction of the population which encounters no cost associated with short-sell￾ing by ct, that fraction which faces proceeds-restrictions by c2, and that fraction which is essentially prohibited from this activity by cs. All traders, independent of whether they are informed or uninformed, fall into one of these three categories, i.e., ci + c2 + cj = 1 at all times. Under the assumption