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Adverse Selection and Large Trade Volume: The Implications for Market Efficiency

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Author Info
Easley, David
O'Hara, Maureen
Abstract

This paper examines the adverse selection problem that arises from the repeated trades of informed traders. We develop a model of trading that incorporates the interaction of expectations, prices, and volume. We then examine how trading volume affects the speed of price adjustment to information, and demonstrate how this price effect differs across markets. Our results suggest that the efficiency of price adjustment to new information may differ dramatically depending on security market structure, even when there is endogenous entry of informed traders. We illustrate these price adjustment properties by developing a simulation of our theoretical model.

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Publisher Info
Article provided by Cambridge University Press in its journal Journal of Financial and Quantitative Analysis.

Volume (Year): 27 (1992)
Issue (Month): 02 (June)
Pages: 185-208
Download reference. The following formats are available: HTML (with abstract), plain text (with abstract), BibTeX, RIS (EndNote, RefMan, ProCite), ReDIF
Handle: RePEc:cup:jfinqa:v:27:y:1992:i:02:p:185-208_00

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  1. Sugato Chakravarty, 2002. "Stealth-Trading: Which Traders' Trades Move Stock Prices?," Finance 0201003, EconWPA. [Downloadable!]
    Other versions:
  2. Robert Engle, 1999. "Modeling the Impacts of Market Activity on Bid-Ask Spreads in the Option Market," University of California at San Diego, Economics Working Paper Series 1999-05, Department of Economics, UC San Diego. [Downloadable!]
    Other versions:
  3. Törbjörn I. Becker & Amadou N. R. Sy, 2005. "Were Bid-Ask Spreads in the FX Market Excessive During the Asian Crisis?," IMF Working Papers 05/34, International Monetary Fund. [Downloadable!]
    Other versions:
  4. Katsuhiko Muramiya & Kazuhisa Otogawa & Tomomi Takada, 2008. "Abnormal Accrual, Informed Trader, and Long-Term Stock Return: Evidence from Japan," Discussion Paper Series 233, Research Institute for Economics & Business Administration, Kobe University. [Downloadable!]
  5. Helder Sebastião, 2008. "The partial adjustment factors of FTSE 100 stock index and stock index futures: The informational impact of electronic trading systems," GEMF Working Papers 2008-07, GEMF - Faculdade de Economia, Universidade de Coimbra. [Downloadable!]
  6. Malay Dey & Hossein Kazemi, 2008. "Bid ask spread in a competitive market with institutions and order size," Review of Quantitative Finance and Accounting, Springer, vol. 30(4), pages 433-453, May. [Downloadable!] (restricted)
  7. Rime, Dagfinn & Sarno, Lucio & Sojli, Elvira, 2009. "Exchange Rate Forecasting, Order Flow and Macroeconomic Information," CEPR Discussion Papers 7225, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
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