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Flow Toxicity and Liquidity in a High-frequency World

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  • David Easley
  • Marcos M. López de Prado
  • Maureen O'Hara

Abstract

Order flow is toxic when it adversely selects market makers, who may be unaware they are providing liquidity at a loss. We present a new procedure to estimate flow toxicity based on volume imbalance and trade intensity (the VPIN toxicity metric). VPIN is updated in volume time, making it applicable to the high-frequency world, and it does not require the intermediate estimation of non-observable parameters or the application of numerical methods. It does require trades classified as buys or sells, and we develop a new bulk volume classification procedure that we argue is more useful in high-frequency markets than standard classification procedures. We show that the VPIN metric is a useful indicator of short-term, toxicity-induced volatility. The Author 2012. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

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Bibliographic Info

Article provided by Society for Financial Studies in its journal Review of Financial Studies.

Volume (Year): 25 (2012)
Issue (Month): 5 ()
Pages: 1457-1493

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Handle: RePEc:oup:rfinst:v:25:y:2012:i:5:p:1457-1493

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Cited by:
  1. Neil Johnson & Guannan Zhao & Eric Hunsader & Jing Meng & Amith Ravindar & Spencer Carran & Brian Tivnan, 2012. "Financial black swans driven by ultrafast machine ecology," Papers 1202.1448, arXiv.org.
  2. Andersen, Torben G. & Bondarenko, Oleg, 2014. "Reflecting on the VPIN dispute," Journal of Financial Markets, Elsevier, vol. 17(C), pages 53-64.
  3. Torben G. Andersen & Oleg Bondarenko, 2011. "VPIN and the Flash Crash," CREATES Research Papers 2011-50, School of Economics and Management, University of Aarhus.
  4. Chung, Dennis Y. & Hrazdil, Karel, 2012. "Speed of convergence to market efficiency: The role of ECNs," Journal of Empirical Finance, Elsevier, vol. 19(5), pages 702-720.
  5. Easley, David & López de Prado, Marcos M. & O'Hara, Maureen, 2014. "VPIN and the Flash Crash: A rejoinder," Journal of Financial Markets, Elsevier, vol. 17(C), pages 47-52.
  6. Tirapat, Sunti & Visaltanachoti, Nuttawat, 2013. "Opportunistic insider trading," Pacific-Basin Finance Journal, Elsevier, vol. 21(1), pages 1046-1061.
  7. Torben G. Andersen & Oleg Bondarenko, 2013. "Assessing Measures of Order Flow Toxicity via Perfect Trade Classification," CREATES Research Papers 2013-43, School of Economics and Management, University of Aarhus.
  8. Rene Carmona & Kevin Webster, 2013. "The Self-Financing Equation in High Frequency Markets," Papers 1312.2302, arXiv.org.

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