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Time-Varying Arrival Rates of Informed and Uninformed Trades

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  • David Easley
  • Robert F. Engle
  • Maureen O'Hara
  • Liuren Wu

Abstract

We propose a dynamic econometric microstructure model of trading, and we investigate how the dynamics of trades and trade composition interact with the evolution of market liquidity, market depth, and order flow. We estimate a bivariate generalized autoregressive intensity process for the arrival rates of informed and uninformed trades for 16 actively traded stocks over 15 years of transaction data. Our results show that both informed and uninformed trades are highly persistent, but that the uninformed arrival forecasts respond negatively to past forecasts of the informed intensity. Our estimation generates daily conditional arrival rates of informed and uninformed trades, which we use to construct forecasts of the probability of information-based trade (PIN). These forecasts are used in turn to forecast market liquidity as measured by bid-ask spreads and the price impact of orders. We observe that PINs vary across assets and over time, and most importantly that they are correlated across assets. Our analysis shows that one principal component explains much of the daily variation in PINs and that this systemic liquidity factor may be important for asset pricing. We also find that PINs tend to rise before earnings announcement days and decline afterwards. Copyright The Author 2008., Oxford University Press.

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Bibliographic Info

Article provided by Society for Financial Econometrics in its journal Journal of Financial Econometrics.

Volume (Year): 6 (2008)
Issue (Month): 2 (Spring)
Pages: 171-207

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Handle: RePEc:oup:jfinec:v:6:y:2008:i:2:p:171-207

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  1. Anat R. Admati, Paul Pfleiderer, 1988. "A Theory of Intraday Patterns: Volume and Price Variability," Review of Financial Studies, Society for Financial Studies, vol. 1(1), pages 3-40.
  2. Alfonso Dufour & Robert F. Engle, 2000. "Time and the Price Impact of a Trade," Journal of Finance, American Finance Association, vol. 55(6), pages 2467-2498, December.
  3. Kerry Back & C. Henry Cao & Gregory A. Willard, 2000. "Imperfect Competition among Informed Traders," Journal of Finance, American Finance Association, vol. 55(5), pages 2117-2155, October.
  4. Engle, Robert F. & Lange, Joe, 2001. "Predicting VNET: A model of the dynamics of market depth," Journal of Financial Markets, Elsevier, vol. 4(2), pages 113-142, April.
  5. Robert F. Engle & Jeffrey R. Russell, 1998. "Autoregressive Conditional Duration: A New Model for Irregularly Spaced Transaction Data," Econometrica, Econometric Society, vol. 66(5), pages 1127-1162, September.
  6. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  7. Chordia, Tarun & Subrahmanyam, Avanidhar & Anshuman, V. Ravi, 2001. "Trading activity and expected stock returns," Journal of Financial Economics, Elsevier, vol. 59(1), pages 3-32, January.
  8. Easley, David & O'Hara, Maureen, 1992. " Time and the Process of Security Price Adjustment," Journal of Finance, American Finance Association, vol. 47(2), pages 576-605, June.
  9. Foster, F Douglas & Viswanathan, S, 1990. "A Theory of the Interday Variations in Volume, Variance, and Trading Costs in Securities Markets," Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 593-624.
  10. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April.
  11. Easley, David & Kiefer, Nicholas M & O'Hara, Maureen, 1996. " Cream-Skimming or Profit-Sharing? The Curious Role of Purchased Order Flow," Journal of Finance, American Finance Association, vol. 51(3), pages 811-33, July.
  12. Hasbrouck, Joel, 1991. " Measuring the Information Content of Stock Trades," Journal of Finance, American Finance Association, vol. 46(1), pages 179-207, March.
  13. Easley, David & Kiefer, Nicholas M & O'Hara, Maureen, 1997. "One Day in the Life of a Very Common Stock," Review of Financial Studies, Society for Financial Studies, vol. 10(3), pages 805-35.
  14. Lee, Charles M C & Ready, Mark J, 1991. " Inferring Trade Direction from Intraday Data," Journal of Finance, American Finance Association, vol. 46(2), pages 733-46, June.
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