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The Accuracy of Trade Classification Rules: Evidence from Nasdaq

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Author Info
Ellis, Katrina
Michaely, Roni
O'Hara, Maureen
Abstract

Researchers are increasingly using data from the Nasdaq market to examine pricing behavior, market design, and other microstructure phenomena. The validity of any study that classifies trades as buys or sells depends on the accuracy of the classification method. Using a Nasdaq proprietary data set that identifies trade direction, we examine the validity of several trade classification algorithms. We find that the quote rule, the tick rule, and the Lee and Ready (1991) rule correctly classify 76.4%, 77.66%, and 81.05% of the trades, respectively. However, all classification rules have only a very limited success in classifying trades executed inside the quotes, introducing a bias in the accuracy of classifying large trades, trades during high volume periods, and ECN trades. We also find that extant algorithms do a mediocre job when used for calculating effective spreads. For Nasdaq trades, we propose a new and simple classification algorithm that improves over extant algorithms.

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

Volume (Year): 35 (2000)
Issue (Month): 04 (December)
Pages: 529-551
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:35:y:2000:i:04:p:529-551_00

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  1. Adam Blazejewski & Richard Coggins, 2004. "A piecewise linear model for trade sign inference," Finance 0412012, EconWPA. [Downloadable!]
  2. Albuquerque, Rui & de Francisco, Eva & Marques, Luis, 2006. "Marketwide Private Information in Stocks: Forecasting Currency Returns," CEPR Discussion Papers 5604, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  3. Michel van der Wel & Albert Menkveld & Asani Sarkar, 2009. "Are Market Makers Uninformed and Passive? Signing Trades in The Absence of Quotes," Tinbergen Institute Discussion Papers 09-046/3, Tinbergen Institute. [Downloadable!]
  4. Joachim Grammig & Erik Theissen, 2003. "Estimating the Probability of Informed Trading - Does Trade Misclassification Matter?," University of St. Gallen Department of Economics working paper series 2003 2003-01, Department of Economics, University of St. Gallen. [Downloadable!]
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  5. John Campbell & Tarun Ramadorai & Tuomo Vuolteenaho, 2004. "Caught On Tape: Predicting Institutional Ownership With Order Flow," Finance 0405012, EconWPA. [Downloadable!]
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  6. Adam Blazejewski & Richard Coggins, 2004. "A local non-parametric model for trade sign inference," Finance 0408009, EconWPA. [Downloadable!]
  7. Bardong, Florian & Bartram, Söhnke M. & Yadav, Pradeep K., 2005. "Informed Trading, Information Asymmetry and Pricing of Information Risk: Empirical Evidence from the NYSE," MPRA Paper 13586, University Library of Munich, Germany, revised 10 Oct 2008. [Downloadable!]
  8. Asani Sarkar & Robert A. Schwartz, 2007. "Market sidedness: insights into motives for trade initiation," Staff Reports 292, Federal Reserve Bank of New York. [Downloadable!]
  9. Asani Sarkar & Robert A. Schwartz, 2006. "Two-sided markets and intertemporal trade clustering: insights into trading motives," Staff Reports 246, Federal Reserve Bank of New York. [Downloadable!]
  10. Roberto Pascual & Bartolomé Pascual-Fuste & Francisco Climent, 2001. "Cross-listing, Price Discovery and the Informativeness of the Trading Process," Business Economics Working Papers wb014511, Universidad Carlos III, Departamento de Economía de la Empresa. [Downloadable!]
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  11. Paiardini, Paola, 2009. "Informed Trading in Parallel Bond Markets," Economics & Statistics Discussion Papers esdp09053, University of Molise, Dept. SEGeS. [Downloadable!]
  12. Andros Gregoriou, 2007. "The Asymmetry of the Price Impact of Block Trades and the Bid-Ask Spread. Evidence from the London Stock Exchange," Money Macro and Finance (MMF) Research Group Conference 2006 76, Money Macro and Finance Research Group. [Downloadable!]
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  13. Rosenthal, Dale W.R., 2008. "Modeling Trade Direction," MPRA Paper 10209, University Library of Munich, Germany. [Downloadable!]
  14. Gregory H. Bauer & Clara Vega, 2006. "The monetary origins of asymmetric information in international equity markets," International Finance Discussion Papers 872, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  15. Joshua V. Rosenberg & Leah G. Traub, 2006. "Price discovery in the foreign currency futures and spot market," Staff Reports 262, Federal Reserve Bank of New York. [Downloadable!]
  16. Alvaro Escribano & Roberto Pascual, 2006. "Asymmetries in bid and ask responses to innovations in the trading process," Empirical Economics, Springer, vol. 30(4), pages 913-946, January. [Downloadable!] (restricted)
  17. Campbell, John Y & Ramadorai, Tarun & Schwartz, Allie, 2007. "Caught On Tape: Institutional Trading, Stock Returns, and Earnings Announcements," CEPR Discussion Papers 6390, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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